Steep value declines in cryptocurrency have sent some investors scrambling to salvage something from the losses. One time-tested method, tax-loss harvesting, may be effective.
“If you’re underwater in your crypto portfolio, you can realize losses to offset other capital asset gains and reinvest in assets that hopefully increase in future value,” said Lou LaValle, managing director of 3iQ Digital Assets (U.S.) in Hoboken, N.J.
Tax-loss harvesting is a straightforward strategy and fairly common practice in the world of traditional assets. Among the nuances of crypto that many clients may not know is that, even though the IRS considers a security sold at a loss and repurchased within 30 days a “wash sale” that can’t be written off, this view doesn't apply to cryptocurrency.
“There’s no 30-day window, which makes crypto tax loss harvesting a more advantageous portfolio strategy, especially during periods of increased market volatility,” LaValle said.
Bitcoin is off roughly 65% from its November all-time high, LaValle said, adding that bitcoin historically has rebounded well from even its deepest dips.
The IRS allows taxpayers to use losses in stocks and other investments, including crypto, to offset gains. If an investor’s losses exceed total gains for the year, the investor can deduct up to $3,000 against taxable income for that year and carry forward the leftover losses to offset gains in future years.
“When you calculate the gain or loss for each sale of crypto, you include how much you paid for the crypto, your cost basis,” said Gail Rosen, a CPA in Martinsville, N.J., who is also a crypto investor.
LaValle offered the example of a buyer who purchases one bitcoin for $40,000 in 2022. Later in 2022, when bitcoin hits $20,000, the buyer sells her one bitcoin and realizes a loss of $20,000. The investor then uses that loss to offset other capital gains and repurchases a bitcoin at $20,000. “[She] owns the same amount of bitcoin today as she did at [the] start of 2022, but at a new cost basis and with a $20,000 capital loss she can apply at year end,” LaValle said.
“You can sell crypto for the loss, then buy back immediately without having to wait 30 days like other investments. This means you can possibly offset this loss against all capital gains ... which will help immediately with taxes,” said Brian Stoner, a CPA in Burbank, Calif.
“Many investors, including myself, currently are buying when the crypto market declines and then we sell when the market starts to climb back up to lock in those tax losses,” Rosen said. “I have a price in mind to buy and sell that at least covers the fee I pay to buy and sell, and my main objective is to lock in my tax losses and replace my crypto.
“I recommend to my clients that they pay for an app to provide them with this cost basis information, since these apps generally match up their sale with the highest cost they paid for the crypto,” she said, adding that this allowable tax method is called HIFO (highest in, first out) and is especially helpful in a falling crypto market.
Tax loss harvesting and buying the token back is not always a win-win.
“One of the best tax strategies is to maximize long-term gains—it’s approximately half the tax rate of short-term gains—meaning you hold crypto for more than a year before selling,” said Andrew Gordon, a CPA and attorney and president of the Illinois-based Gordon Law Group. “If you sell your crypto and buy it back, you've reset the holding period, meaning you need to wait an additional year to have a long-term gain.”
There are also other factors to consider before triggering a tax-loss harvesting strategy, LaValle said.
“Investors should factor in transaction costs when buying and selling, and what future capital gains might look like with a newly adjusted cost basis,” he said. “At certain times, it might not make sense to harvest losses.”