What is Crypto Tax Loss Harvesting?
|— Your crypto portfolio needs to be taken into account in your end-of-year tax return.|
— As with any element of your portfolio, understanding exactly how your crypto tax will be treated – and what your options are – puts you in the best possible position to manage your tax return.
— Here, crypto tax experts ZenLedger explain the practice of tax loss harvesting, and how it applies to your crypto.
**The information within this article relates to the US tax system exclusively, and should not be applied to any other tax regime.
You may not be in control of the markets, but you are absolutely in control of how you handle your crypto portfolio. ZenLedger is a crypto tax platform dedicated to giving you expert tax advice for your crypto portfolio – and you can connect to ZenLedger easily, through Ledger Live.
In the latest guest article from our crypto tax mini-series, ZenLedger explains tax loss harvesting – one simple way of managing your crypto taxes efficiently. You need to harvest before the end of the year though or you won’t be able to use your losses on this year’s taxes, so let’s dive in and see what crypto tax loss harvesting means, and how it might help you.
How Crypto Taxes Work
Before we tackle tax loss harvesting, it’s important to define some key terms and concepts, and how those fit into the broader picture of crypto.
Personal taxes are divided into two categories: ordinary income tax and capital gains tax. However, the possibility of tax loss harvesting originates from your crypto capital gains, so let’s start by properly unpacking that concept.
What’s a Crypto Capital Gain?
Generally speaking, ordinary income is money that you earn. In the context of crypto, this could come from staking, lending, airdrops, liquidity pools, royalties, and a variety of other crypto activities. We’ll come back to that.
But alternatively, some of the income you make from your crypto holdings might be classed as a capital gain. While ordinary income taxes are assessed when you make money, capital gains tax is assessed when your assets make money. In other words, when an investment goes up or down in value, relative to its original cost basis.
What’s the Cost Basis?
The original value of an investment is called its “cost basis.” So for example, if you initially bought a given amount of tokens for $1000, you’d have a cost basis for that holding of $1,000.
Your capital gains on that holding are calculated by taking the price you sold your coin at and subtracting your cost basis. So for example, if those same tokens then went up in value to $3,000 and subsequently you sold them, you would have made $2,000 in capital gain. This is the amount you would report to your tax authority.
Capital Gains Holding Period
Your capital gains tax is determined not only by the gain you’ve made on your investments but by how long you held that asset before selling it. This is otherwise known as your “holding period.” Your holding period will determine whether the gain in question was long-term or short-term which, in turn, determines the rate of tax that will be applied.
In the US, short-term capital gains are taxed at your ordinary income tax rate, while long-term capital gains are taxed at a lower capital gains rate. Generally, you must hold an asset for at least one year to qualify for the long-term capital gains rate.
Where does tax loss harvesting fit into all of this?
How Crypto Tax Loss Harvesting Works
As you know, you’ll be taxed on any capital gains you make – but conversely, your losses can also be used to offset gains, reducing your overall tax bill.
What’s important is that you can only claim a loss (and benefit from the tax reduction it brings) when you actually realize the loss – i.e., when you sell the asset for less than you paid for it.
Tax Loss Harvesting Examples
- Capital gains offset
Let’s say you bought $BTC worth $10,000 two years ago and sell it today for $5,000. You realized a $5,000 long-term capital loss, which you can use to offset up to $5,000 in capital gains in the current tax year. Let’s also say you realized a long-term capital gain of $2,000 on the sale of ETH at the same time. You would not owe tax on your ETH gain because it would be fully offset by your BTC loss.
- Ordinary income offset
You can also use capital losses to offset up to $3,000 of ordinary income per year. If you made $60,000 in salary last year and had $5,000 in losses on your cryptocurrency, you can use up to $3,000 of your losses to reduce your ordinary income to $57,000. For most people, that would save them about $1,000 in taxes. Meanwhile, the remaining $2,000 of losses can be “carried forward” and used to reduce your taxes for the next year.
These are just two examples of how tax loss harvesting might apply to a given tax return, but the overarching message is consistent – knowing the details of how tax works, and how certain rules apply to crypto, can directly benefit you.
Knowing What – and When to Sell
A word of caution: You need to harvest a loss (e.g., by selling the asset) by December 31st or you won’t be able to use your losses on this year’s taxes.
Tax isn’t the easiest subject to understand at the best of times – and can be even trickier when it comes to your crypto portfolio. But luckily, you’re not on your own.
ZenLedger is here to help you analyze your crypto portfolio and make informed decisions when it comes to your crypto tax. ZenLedger.io aggregates all your crypto transactions from your various exchange accounts and wallets together into one place.
They compute your crypto income, short-term and long-term capital gains, and can even help you spot opportunities for tax loss harvesting, and execute your strategy properly.
Take a look:
ZenLedger.io gives you PDFs of your tax forms that you can use to file, or give to your accountant. If you have a TurboTax or TaxAct account, you can even import your crypto tax information directly from ZenLedger.io.
Cryptocurrency markets are volatile. But handled properly, that same volatility could present opportunities for you to manage your tax bill efficiently, or even lower your income tax rate.
All it takes for you to get the best out of your crypto portfolio is a little knowledge and guidance – and that’s what ZenLedger is here for. Find it in the Ledger Live app.
**The details contained in this article are for informational purposes only and are of a general nature. Nothing contained in this article constitutes tax, legal, financial, or investment advice nor is it not intended as a recommendation for buying, trading, or selling crypto assets. References to any securities or digital assets are for illustrative purposes only. Crypto assets are volatile. You should be fully aware of the level of risk involved before engaging in crypto-related activities. Please educate yourself to make informed decisions. It is recommended to seek independent advice from reliable and qualified experts before engaging in such activities and on your tax affairs. Any loss of data, crypto assets, or profit is your sole responsibility. Ledger is not responsible for the consequences of reliance upon any opinion or statement contained herein or for any omission.