What You Need to Know About Crypto Tax Loss Harvesting

Tax-loss
harvesting
is
a
strategy
that
you
can
use
to
minimize
your
tax
liability.
By
selling
investments
with
unrealized
losses,
you
can
realize
a
capital
loss
that
you
can
use
to
offset
capital
gains
made
on
other
investments
or
up
to
$3,000
in
ordinary
income
each
year.

The
controversial
part
of

tax-loss
harvesting
comes
if
and
when
you
repurchase
the
investment.
If
you
immediately
repurchase
the
same
investment,
you’ve
essentially
represented
that
you
lost
money
when
you
haven’t
really
lost
anything
–
you
still
own
the
same
asset!

The
IRS
discourages
these
superficial
transactions
with
the

Wash
Sale
Rule.
While
the
agency
hasn’t
clarified
whether
the
rule
applies
to
cryptocurrencies,
many
regulators
and
legislators
have
expressed
interest
in
closing
what
they
see
as
a
loophole.

In
this
article,
we’ll
get
you
up
to
speed
on
what
a
wash
sale
is,
the
rules
applying
to
them,
and
how
you
can
time
your
trades
to
avoid
running
afoul
of
these
complicated
rules.

IRS
Publication
550
defines
a
“wash
sale”
as
a
sale
that
occurs
when
you
sell
or
trade
stock
or
securities
at
a
loss
and
within
30
days
before
or
after
the
sale
you:

This
definition
begs
the
question:
What
is
a
“substantially
identical”
stock
or
security?

The
IRS
says
you
must
“consider
all
the
facts
and
circumstances
in
your
particular
base”
when
making
that
determination.
As
an
example
of
this
ambiguity,
ordinary
stocks
or
securities
of
one
corporation
are
generally
not
substantially
identical
to
those
of
another.
But,
in
a
reorganization,
the
predecessor’s
stock
may
be
“substantially
identical.”

The

Wash
Sale
Rule
prohibits
investors
from
deducting
the
sales
or
trades
of
“stock
or
securities”
in
a
wash
sale
(unless
you’re
a
dealer
in
stock
or
securities).

If
you
think
about
it,
selling
stock
to
realize
a
loss
and
immediately
repurchasing
the
asset
results
in
a
net-unchanged
economic
position
for
you.
You
owned
the
same
asset
with
the
same
economic
exposure
as
before
–
you’re
only
changing
your
cost
basis!

The
IRS
doesn’t
want
you
to
deduct
losses
on
an
investment
if
you
haven’t
actually
incurred
an
economic
loss.
In
other
words,
they’re
okay
with
deducting
a
loss
if
you
sell
an
investment
and
move
on
to
a
different
one.
But
not
if
you
maintain
your
same
exposure.

The
only
exception
occurs
if
you
sell
several
securities
and
repurchase
far
fewer.
In
that
case,
the
IRS
lets
you
specify
which
shares
you
want
the
Wash
Sale
Rule
to
apply
to.

The
IRS
states
that
the
Wash
Sale
Rule
applies
to
“stock
or
securities”
but
hasn’t
clarified
whether
that
means
cryptocurrencies.
Currently,
the
IRS
considers
cryptocurrencies
“property”
rather
than
“securities,”
which
suggests
that
the
rules
don’t
apply
at
the
moment.

However,
legislators
seem
keen
on
applying
the
Wash
Sale
Rule
to
crypto
investors.
For
instance,
on
July
12,
2023,
a
bipartisan
group
of
Senators
reintroduced
the

Lummis-Gillibrand
Responsible
Financial
Innovation
Act
to
create
a
regulatory
framework
for
digital
assets
and
apply
the
Wash
Sale
rule
to
digital
assets.

Moreover,
even
if
the
Wash
Sale
Rule
did
apply
to
cryptocurrencies,
the
IRS
would
have
to
provide
guidance
on
how
to
treat
certain
transactions.
There
is
a
lot
of
ambiguity
surrounding
how
one
might
interpret
whether
tokens
are
“substantially
identical.”

For
example,
different
tokens
on
the
same
blockchain
are
unlikely
to
be
“substantially
identical”
because
they
have
different
functionalities
and
use
cases.
For
instance,
ETH
and
ERC-20
tokens
are
incredibly
different
in
their
economics
and
the
rationale
for
ownership.

However,
several
crypto
assets
could
fall
under
the
“substantially
identical”
designation:

Since
there’s
no
clear
guidance
from
the
IRS,
these
scenarios
would
be
up
for
interpretation.
If
you’re
not
clear
and
wish
to
follow
the
Wash
Sale
Rule,
just
in
case,
the
safest
approach
would
be
to
consult
a
tax
advisor
familiar
with
crypto
assets.

The
Wash
Sale
Rule
applies
to
transactions
made
30
days
before
or
after
the
sale.
So,
even
if
you
wait
to
repurchase
the
asset
until
30
days
after,
you
also
must
have
not
purchased
it
originally
within
30
days
beforehand
to
avoid
a
wash
sale.

In
addition,
it’s
critical
to
remember
that
the
Wash
Sale
Rule
applies
to
all
your
accounts.
So,
even
if
you
haven’t
purchased
Bitcoin
in
one
wallet
over
the
past
30
days,
the
loss
may
be
invalid
if
you
purchased
it
on
a
different
exchange.

For
example,
suppose
that
you
purchased
$50,000
worth
of
bitcoin
on
Coinbase.
After
40
days,
the
price
fell,
and
you
sold
the
position
for
$40,000,
incurring
a
$10,000
loss.
Then,
in
a

Ledger
wallet
transaction,
you
repurchased
Bitcoin
for
$42,000
five
days
later.

In
this
scenario,
you
would
have
to
disallow
the
$10,000
loss
for
tax-deduction
purposes.
Instead,
the
$10,000
loss
would
be
added
to
the
cost
basis
of
the
new
Bitcoin
you
purchased,
making
the
new
cost
basis
$52,000
($42,000
+
$10,000).

If
you
want
to
avoid
the
wash
sale,
the
sale
transaction
would
have
had
to
occur
between
Day
10
(30
days
before
Day
40)
and
Day
70
(30
days
after
Day
40).
Alternatively,
you
could
have
repurchased
a
different
asset
instead
of
Bitcoin
(such
as
Ethereum)
and
realized
the
tax
loss.

The
easiest
way
to
avoid
mistiming
tax-loss
harvesting
transactions
is
to
use
an
automated
tool
to
identify
valid
opportunities.
By
relying
on
algorithms,
these
tools
can
automatically
determine
eligible
assets
and
factor
in
all
your
wallets,
exchanges,
or
other
accounts.
For
example,

ZenLedger’s
tax
loss
harvesting
tool
can
help
you
pinpoint
opportunities
at
any
time
because
of
the
ability
to
track
accurate
cost-basis
across
an
entire
portfolio.

The

accounting
methods
you
use
to
determine
cost
basis
could
also
impact
your
tax
loss
harvesting
strategy.
While
these
methods
don’t
directly
impact
the
Wash
Sale
Rule,
they
can
affect
how
a
wash
sale
is
calculated
or
identified
and
influence
your
taxes.

For
example,
FIFO
(first
in-first
out),
LIFO
(last
in-first
out),
and
other
accounting
methods
affect
the
cost
basis
of
the
assets
you
use
to
“replace”
the
ones
you
sold
in
a
wash
sale.
This
altered
cost
basis
carries
forward
to
future
sales,
affecting
the
calculation
of
your
capital
gains
or
losses.

In
addition,
if
a
wash
sale
occurs,
the
disallowed
loss
is
generally
added
to
the
cost
basis
of
the
new
“substantially
identical”
security.
This
rule
may
affect
your
portfolio
differently
depending
on
your
accounting
method.

The
IRS’
Wash
Sale
Rule
doesn’t
necessarily
apply
to
cryptocurrencies
yet,
but
conservative
investors
may
want
to
follow
the
rules
anyway.
If
you
fall
under
that
group
of
investors,
understanding
the
timing
around
wash
sales
can
help
you
make
the
most
of
your
tax-loss
harvesting
efforts
and
avoid
running
afoul
of
any
future
rules
and
regulations.

The
above
is
for
general
info
purposes
only
and
should
not
be
interpreted
as
professional
advice.
Please
seek
independent
legal,
financial,
tax,
or
other
advice
specific
to
your
particular
situation.