I am a certified public accountant that is based out of New Jersey, and I'm continuing my extensive guide covering the interactions of United States tax law and cryptocurrency. You can view the first part on LeoFinance, my own blog, Medium, Reddit, and Publish0x.
Tax loss harvesting is a strategy to reduce the amount of taxes you have to pay on your capital gains or ordinary income. The idea is very simple: if you have capital gains in a given year, you sell off your investments that you are currently holding at a loss to offset those gains. Even in a year where you have no capital gains, up to $3,000 of capital losses can be deducted to offset your ordinary income.
Long-term losses can even offset short-term gains, and short-term losses can offset long-term gains. Although, offsetting your long-term gains may not be as beneficial as you are already being taxed at the preferred long-term capital gains tax rates.
A wash sale occurs when you sell off a security at a loss, and had purchased or will purchase the same security within 30 days.
When a wash sale occurs, you are disallowed from deducting that capital loss. If your loss was disallowed due to a wash sale, you add the loss to the basis of your newly purchased securities. This is your new basis, which should match up exactly with the original basis that you had previously.
To recap: tax loss harvesting is a strategy to reduce your taxes paid by selling your investment property at a loss. Wash sales disallow losses when a security is sold a loss, and repurchased within 30 days.
Tax loss harvesting with cryptocurrency is a legitimate method of reducing your tax burden. If you made an exchange or sale of $ETH that resulted in a capital gain, exchanging or selling your $TRAC that's currently down could reduce or even eliminate your cryptocurrency tax burden. Note: you are still required to report all of these exchanges in full to the IRS.
Wash sales tend to get a little bit more complicated. If we look at Publication 550, and head on down to the section on wash sales, you will notice the first sentence: "You cannot deduct losses from sales or trades of stock or securities in a wash sale unless the loss was incurred in the ordinary course of your business as a dealer in stock or securities."
Publication 550 specifically references stocks and securities. The IRS does not appear to consider cryptocurrency to fall under this definition. This has led many investors to believe that wash sale rules do not apply to cryptocurrency transactions. You could sell your $TRAC at a loss, and then immediately repurchase them back at the same price. Now you've offset your gain in $ETH, but are still able to hold your $TRAC.
I think it's important to remember that when it comes to the IRS: a lack of guidance on a specific issue does not necessarily mean that you should assume the more favorable outcome to be the correct one. Sometimes, common sense is a better tool to use than (the lack of) IRS publications. Taking a riskier tax position could result in having to pay these taxes at a later year. Additionally, if guidance does emerge that states that cryptocurrency does not fall under wash sale rules, you always have the option to amend your return and take those losses. (Note: there is a three-year limit to filing an amended return to claim a refund) Deciding whether or not to apply wash sale rules to cryptocurrency should be a conversation between you and someone who understand your personal circumstances (and hopefully cryptocurrency).
Edit: u/infamouspaghetti on Reddit points something out that should be considered before engaging in tax harvesting: "the issue with tax loss harvesting is resetting your holding period and reestablishing your position with a lower basis (i.e. more gain in the future.)." This is something to consider. If you do find yourself having to sell your position next year, and the cryptocurrency does appreciate, you may find yourself with some short-term capital gains that fall under your ordinary tax rate. Note: this effectively does not matter if you do apply the wash sale rules to cryptocurrency, as the wash sale rules push your basis back to what it was originally, and modify your holding period to include the time of the original purchase date.
If you have any questions, feel free to ask them below. They can relate to the items above or about anything else that is tax related. If you have anything else that you'd like me to cover, please let me know. My current list is below, let me know which one you'd like me to cover next!
- Cost basis accounting
- Gift taxes
- Transaction fees and nontaxable events
- Will IRS treatment change? What does that mean for my prior year returns?
This material, and any responses below, have been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, investment, or accounting advice. You should consult your own tax, legal, investment, or accounting advisors before engaging in any transaction.