FIRM1040 Blog

Loophole: Harvest Tax Losses on Bitcoin and Crypto

Here’s something to know about cryptocurrencies.


Because cryptocurrencies are classified as “property” rather than as securities, the wash-sale rule does not apply if you sell a cryptocurrency holding for a loss and acquire the same cryptocurrency before or after the loss sale.


You just have a garden-variety short-term or long-term capital loss depending on your holding period. No wash-sale rule worries.


This favorable federal income tax treatment is consistent with the long-standing treatment of foreign currency losses.


That’s a good thing, because folks who actively trade cryptocurrencies know that prices are volatile. And this volatility gives you two opportunities:


1. profits on the upswings

2. loss harvesting on the downswings


Let’s take a look at the harvesting of losses:


· On day 1, Lucky pays $50,000 for a cryptocurrency.

· On day 50, Lucky sells the cryptocurrency for $35,000. He captures and deducts the $15,000 loss ($50,000 - $35,000) on his tax return.

· On day 52, Lucky buys the same cryptocurrency for $35,000. His tax basis is $35,000.

· On day 100, Lucky sells the cryptocurrency for $15,000. He captures and deducts the $20,000 loss ($35,000 - $15,000) on his tax return.

· On day 103, Lucky buys the same cryptocurrency for $15,000.

· On day 365, the cryptocurrency is trading at $55,000. Lucky is happy.


Observations:


· Assuming Lucky had $35,000 in capital gains, Lucky deducted his $35,000 in cryptocurrency capital losses. If he had no capital gains, he had a $3,000 deductible loss and carried the other $32,000 forward to next year.

· On day 365, Lucky has his cryptocurrency, which was his plan on day 1. He thought it would go up in value. It did, from its original $50,000 to $55,000.

· Lucky’s tax basis in the cryptocurrency on day 365 is $15,000.


Here’s what Lucky did:


1. He kept his cryptocurrency.

2. He banked $35,000 in losses.


Be alert. Losses from crypto-related securities, such as Coinbase, can fall under the wash-sale rule because the rule applies to losses from assets classified as securities for federal income tax purposes. For now, cryptocurrencies themselves are not classified as securities.


Planning point. If you want to harvest losses, make sure you hold a cryptocurrency and not a security.


If you would like to discuss cryptocurrencies, please call me on my direct line at 973-339-7773.

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