If you are a crypto investor, like me, you probably realize that 2022 was a roller coaster year for crypto trading. Bitcoin has fallen 64%, and Ethereum has lost 66% of its valuation in 2022. Some people may lose all the crypto trading gains that they earned from the years before.
While the crypto trading market may be down, taxpayers can still come out ahead through careful tax planning. You can minimize the tax burden and potentially save money in this type of situation.
In this article, we are going to discuss 3 tax saving tips for your crypto investment. However, it is important to consult with a tax planning professional to ensure that you are taking advantage of all available tax saving opportunities.
By definition, loss harvesting is simply realizing losses by selling off a position with an unrealized loss. An unrealized loss means the investment is currently worth less than the cost basis (the original purchased price) yet you still own it. For example, you purchased 1 bitcoin in 4/22/2021 worth $51,730, and the value of one bitcoin today (12/18/2022) is at $16,695.47. There is no tax consequence on this investment until you sell it.
If the price of bitcoin is continue fallen, you can sell the bitcoin and get the cash of $16,695.47 to use for any other type of investment. From a tax perspective, you will have a capital loss of $34,674.83. If you have other investments with a capital gain, the capital loss from crypto trading will offset the capital gain.
After that, if there are still losses, you can use up to $3,000 ($1,500 for Married Filing Separate) to offset ordinary income. Any remaining loss carries over into the subsequent year.
Long Term Capital Gains
Long term capital gains are preferential tax rates for realized gains that have a holding period of more than one year. The tax rate of long term capital gain is ranged from 0 to 20%, depending on the taxpayer’s adjusted gross income (AGI). Therefore, if a taxpayer’s AGI is below the threshold, he/she can essentially realize gains tax free because those gains are in the 0% brackets.
For example, you are going to file as head of household in 2022, and your AGI is $55,750. You are under the threshold of 0% long term gain tax rate ($55,800 for head of household). You purchase some coins in January 2021 worth of $500, and luckily the coin’s value is increased to $10,000 in May 2022. You decide to sell all the coins in May 2022, so the gain of your investment would be $9,500 ($10,000 - $500). Since you hold the coins for more than one year, so the gain will be treated as an long term capital gain. The long term capital gain tax rate in your case is 0%, which means you don’t need to pay any tax for the gain.
Benefits for Digital Assets- Wash Loss Rule
For instance, if you own some stock of Apple worth $8,000, and you sell them on the next day for $7,000, so you will have a capital loss of $1,000. After 3 days you sold your Apple stocks, and you figured out that the stock price could go a lot higher the next week after the new iPhone is launched, so you buy back the same amount of shares at $8,150. However, in this case, the wash loss rule is applied. The $1,000 capital loss that you had 3 days ago is going to wash out, and it won’t offset any capital gain from your other investments.
As of the last day of 2022, the wash loss rule does not apply to cryptocurrency since they do not meet the definition of “securities” for the purposes of Section 1091. (The IRS treats cryptocurrency as a digital asset). This means a taxpayer can sell a losing position and reacquire it in fewer than 30 days and still maintain the capital loss.
For instance, you purchased a coin worth $500 on day 1, and you sell it on day 2 for $300. In this case, you have a capital loss of $200. On day 10, you purchased the same coin again for $350. You sell it on the last day of the year for $800, so you have a capital gain of $450. Since the wash loss rule will not apply, so you only need to pay tax for the gain of $250.
Taxpayers can carefully analyze unrealized gains and losses of the overall investment to minimize the tax on their investment income each year. Once you come up with a good plan on how to handle unrealized gains and losses, you can put them into action. Loss harvesting is an easy way to offset capital gains from other investments. Maximizing the benefit of the 0% long term bracket can allow taxpayers to realize gain tax free. Investors in cryptocurrency can use the additional benefit of not being subject to the wash loss rule.