Tax Loss Harvesting: Offsetting Crypto Losses [IRS Rules 2024]

Master the art of tax loss harvesting with our guide on IRS rules, helping you strategically offset crypto losses for optimal tax benefits.

Expert verified
by
Mag. Georg Brameshuber

Key Takeaways

  • Strategic Benefit of Tax Loss Harvesting: Selling underperforming crypto assets can reduce taxes by offsetting taxable income with capital losses.
  • Importance of Accurate Record-Keeping and Reporting: Proper record-keeping and reporting, with tools like Blockpit, are crucial for compliance and leveraging tax loss harvesting.
  • Navigating IRS Rules and Timings: Knowing IRS guidelines and timing asset sales based on short-term vs. long-term gains is key to maximizing this strategy.
Written by
Florian Wimmer
Last Updated:
February 21, 2024
Chapter 1

Understanding Crypto Tax Loss Harvesting

Demystifying the Process and Strategies for Effective Tax Loss Harvesting in Cryptocurrency Investments.

<div fs-richtext-component="info-box" class="info-box"><div class="flex-info-card"><img src="https://assets-global.website-files.com/65098a145ece52db42b9c274/650c6f4cef4c34160eab4440_Info.svg" loading="eager" width="64" height="64" alt="" class="icon-info-box"><div fs-richtext-component="info-box-text" class="info-box-content"><p class="color-neutral-800">Starting January 1, 2024, the Infrastructure Investment and Jobs Act requires reporting 10,000$+ crypto transactions to the IRS. Yet, the Treasury and IRS deferred digital asset reporting until new regulations are set, promising future guidance and public input on these rules. Stay informed: IRS</p></div></div></div>

Tax loss harvesting is essential for minimizing taxes by offsetting losses from trading digital assets. It requires strategically selling underperforming digital assets, with careful attention to IRS rules, to reduce tax liabilities. This guide explains implementing this strategy compliantly for digital assets.

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What is Crypto Tax Loss Harvesting?

Crypto tax loss harvesting is a tactic to decrease tax liabilities by selling assets at a loss, leveraging the drop in cryptocurrency value to realize a loss. This realized loss can offset taxable gains from other profitable investments. By strategically selling assets to realize losses, investors can lessen their overall taxable income and capital gains taxes, aiming to reduce their tax bill effectively.

Core Benefits of Crypto Tax Loss Harvesting

  • Reduced Tax Bill: Offset capital gains with losses to reduce annual tax liability.
  • Offset Ordinary Income: Use excess losses to lower taxable ordinary income for financial relief.
  • Reinvestment Flexibility: Immediate repurchase of cryptocurrencies allowed, maintaining market position.
  • Enhanced Portfolio Performance: Disciplined management and optimized asset allocation improve long-term outcomes.
  • Buffer Against Future Gains: Use loss carryforwards from bearish periods to offset future taxable gains.
  • Emotional Upside: Leverage tax advantages during downturns for a positive spin on crypto volatility.

Understanding Capital Gains and Losses

Understanding the difference between short-term and long-term capital gains and losses is essential in the realm of cryptocurrency taxation. These distinctions determine your tax obligations and can profoundly influence your investment decisions.

Short-term Capital Gains/Losses

  • Duration: Assets, including cryptocurrencies, sold after holding for one year or less.
  • Taxation: Taxed at your ordinary income tax rates, which might be higher than long-term rates (10% - 37%).

Long-term Capital Gains/Losses

  • Duration: Assets held for more than one year before selling.
  • Taxation: Usually taxed at preferential rates, often lower than ordinary rates (0%, 15%, or 20% for most).

Tax loss harvesting sorts losses into short-term (assets held under a year) and long-term (held over a year), aiming to offset respective gains. Excess losses in one category can offset gains in the other, reducing overall tax liability by balancing gains with strategic losses.

Carrying Crypto Losses Forward

Crypto losses exceeding gains can be carried forward, offering future offset potential. In the U.S., up to 3,000$ of net loss can offset ordinary income annually. Excess over 3,000$ carries forward, e.g., a 10,000$ net loss allows a 3,000$ offset plus a 7,000$ carryforward to future years, used until fully depleted.

examples of crypto tax loss harvesting
Tax Loss Harvesting Example

Implementing a tax-loss harvesting strategy requires thorough knowledge of one's portfolio and positions. Blockpit’s Tax Optimization Feature allows you to identify unrealized gains and losses as well as the holding period of your assets.

Blockpit's tax optimization feature
Blockpit's Tax Optimization Feature
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Chapter 2

Step-by-Step Guide

Exploring the Advantages and Practical Approaches to Tax Loss Harvesting in the Crypto Market

Step-by-Step Guide to Crypto Tax Loss Harvesting


Step 1: Evaluate Your Crypto Portfolio
Start by reviewing your cryptocurrency investments to determine each asset's original purchase price or "cost basis," essential for calculating gains or losses.

Step 2: Spot Underperforming Assets
Utilize crypto tracking tools and analyze financial metrics to identify assets that have decreased in value compared to their cost basis, indicating a potential loss.

Step 3: Execute Sales
To utilize the loss for tax purposes, you must sell the asset. Consider the timing for tax optimization and how it fits your wider financial strategy and portfolio impact.

Step 4: Considerate Reinvestment
Cryptocurrencies are not clearly subject to the "wash-sale" rule like stocks. When reinvesting, choose assets that meet your investment goals and risk appetite, keeping regulatory clarity in mind.

Navigating the Wash Sale Rule

The wash sale rule prevents claiming tax deductions for losses on securities sold and repurchased within a 30-day period, aiming to avoid artificial tax losses.

But, Does It Apply to Cryptocurrencies?

Cryptocurrencies, classified as property by the IRS, currently fall outside this rule, allowing investors to sell crypto at a loss and immediately repurchase, utilizing the loss to offset capital gains or up to 3,000$ of income while retaining their position. Given the changing regulatory environment, it's vital to stay informed on IRS updates regarding cryptocurrency.

crypto wash sale rule explained
Wash Sale Rule Example
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Chapter 3

Navigating Crypto Tax-Loss Harvesting

Strategies, Reporting, and Common Mistakes

When is the Optimal Time to Implement Tax-Loss Harvesting for Crypto?

The optimal time for tax-loss harvesting in crypto generally is:

1. Near Year-End: To offset gains made during that year.

2. After Market Dips: When many positions might be at a loss.

3. Before Making Big Sales: To offset expected large capital gains.

Reporting Crypto Losses on Tax Returns

Report all crypto transactions on IRS Form 8949 and summarize gains or losses on Schedule D of Form 1040. Given crypto's volatility and transaction volume:

  • Keep detailed records of transactions, including dates, amounts, and cost basis.
  • Document each transaction's fair market value.
  • Note details of gifts or non-sale transfers.
  • Use crypto tax software like Blockpit for easier tracking and reporting. Accurate documentation is crucial for compliance and audit preparation, especially with the IRS's growing focus on crypto.

Pitfalls to Avoid

Common mistakes in crypto tax loss harvesting are:

  1. Misunderstanding the Wash Sale Rule: Unlike traditional securities, cryptocurrencies currently aren't bound by the wash sale rule, but always stay updated with IRS guidelines.
  2. Confusing Short-term vs. Long-term: Assets held under or over a year are taxed differently. Ensure proper differentiation.
  3. Overlooking Transactions: All transactions, including crypto-to-crypto trades, gifts, and forks, need reporting.
  4. Inadequate Record Keeping: Proper and complete records prevent reporting errors and missed harvesting opportunities.
  5. Assuming Exchange Accuracy: Not all exchanges provide comprehensive or accurate tax reports. Always validate the data.


Implications of Misreporting:

  1. Penalties: Underreporting can result in penalties from the IRS, ranging from minor fines to significant amounts if deemed fraudulent.
  2. Audits: Inaccuracies can flag an IRS audit, leading to added stress, potential additional taxes, and further penalties.

Being vigilant about these pitfalls and regularly consulting updated tax guidelines or professionals ensures smoother crypto tax reporting and optimal tax loss harvesting.

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Chapter 4

Your Blockpit Crypto Tax Report

Use Blockpit's Tax Optimization Feature for Tax Loss Harvesting

Optimize & File Your Crypto Taxes With Blockpit

Blockpit creates the most comprehensive crypto tax reports in PDF format. The report provides information about all your balances and transactions and can be used as proof of origin with banks or tax advisors. It contains all relevant transactions of your account in the selected tax year and shows details such as timestamp, amount, asset, costs and fees of the individual transactions.

Using Blockpit couldn’t be easier:

1. Import your transactions

Blockpit offers direct integrations for crypto exchanges, wallets and DeFi protocols. Automatically import your transactions via API integration, wallet address synchronization, or by manually uploading an Excel file.

Discover all crypto integrations

2. Validate & Optimize

Blockpit offers smart insights and suggestions to optimize your tax report, fix issues, add missing values and to validate your transactions. Blockpit’s Tax Optimization Feature allows you to identify unrealized gains and losses as well as the holding period of your assets.

3. Generate your tax report

Generate your compliant tax report with the click of a button. Our tax engine calculates your tax report on the basis of the US tax framework.

US Blockpit Crypto Tax Report Overview
US Blockpit Crypto Tax Report Form 1040
US Blockpit Crypto Tax Report Capital Gains and Losses Summary

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FAQ

Sources & References
  • Omri Marian, Professor of Law, University of California, Irvine School of Law
  • 74 sec. 165 IRC 1986.
  • 75 sec. 165(c), (h) id.
  • 76 Treas. Regs. Sec. 1.165-1(d)
  • 77 IRS CCA 202302011, Applicability of I.R.C. Section 165 to Cryptocurrency that Has Declined in Value (Jan. 13,2023).
  • 78 J.C. Hubres, Everything We Know — and Don’t — About Taxing Cryptocurrency, 178 Tax Notes Federal 1699, p.1707 (13 Mar. 2023).
  • 79 sec. 165(g) IRC 1986.
Update Log
Disclaimer: The information provided in this article is for general information purposes only. The information was completed to the best of our knowledge and does not claim either correctness or accuracy. For detailed information on crypto regulations, we recommend contacting a certified legal advisor in the respective country.