Crypto Tax Loss Harvesting: How Tax Harvesting Works? Does It Work On Crypto Losses?

The cryptocurrency market has been fighting off bears for more than a year. Additionally, there is a sharp decline in cryptocurrency market capitalization. The changes to crypto tax laws in almost every nation in the world added more fuel to the fire. Besides, every cloud has a silver lining, and in this case, it is crypto tax-loss harvesting, a method whereby investors can sell assets for a loss and save taxes.

In this article, we are decoding crypto tax-loss harvesting, mechanisms, and reporting of crypto losses.

What is crypto tax-loss harvesting?

A tax-loss harvesting strategy in cryptocurrencies entails putting off cryptocurrency at a loss and making up the difference with capital gains from selling other crypto assets. Typically, crypto tax harvesting is a strategy of offsetting capital gains with capital losses.

Crypto tax loss harvesting is possible only when multiple cryptocurrencies are in the portfolio. To claim a loss in the crypto asset, the investor must sell tokens and use the proceeds to purchase similar coins within 30 days of sale. The process is named ‘the wash sale rule.’ Cryptocurrency tax loss harvesting is extremely beneficial for lowering one’s tax burden.

Let’s understand with the help of an example: suppose investor Z bought crypto for $12,000 and later booked a profit of $3,000 by selling it for $15,000. The capital gain incurred by Z will be $3,000. To offset the capital gain, the investor will have to suffer a loss of $3,000.

Many nations place restrictions on how capital losses can be adjusted; they are only allowed to be used to offset capital gains. Additionally, some laws set a specific threshold for the offset.

How does tax-loss harvesting in crypto work?

Crypto tax-loss harvesting compensates capital gains with capital losses. The strategy is to harvest the loss to offset gains and income simultaneously. The transaction proceeds can then be replaced by another asset to achieve the best outcome while lessening the tax liability. This is how investors can utilize the crypto tax-loss harvesting:

• Evaluating the portfolio: A thorough understanding of one’s cryptocurrency portfolio is essential. It makes the buying and selling of tokens easier to comprehend. Additionally, planning which token to sell to record a loss and offset capital gains will be made easier.
• Timeframe: The capital gains and losses may be carried forward to the subsequent month or the following year. It can assist investors in using the strategy while making longer-term investments.
• Capital gains adjustments: Capital gains directly impact the tax slabs. Selling off cryptocurrencies at a loss can immediately offset capital gains with losses.
• Plan the capital loss: The entire phenomenon of tax loss harvesting revolves around capital losses. Usually, identifying capital losses is simpler than identifying gains. Thus, cryptocurrency investors can significantly reduce their tax burden with careful planning.

Limitations of crypto tax-loss harvesting

All tax-reducing strategies entail certain risks. The tax loss harvesting has limitations as well. Here are the risks of crypto tax-loss harvesting.

• Complicated: Many people find it difficult to implement crypto tax loss harvesting. The complexity of the plan is further increased by altering bylaws. The complexity of the taxes is likely to rise over time. Eventually, it would be difficult to keep up with the crypto tax-loss harvesting.
• Varied tax laws: The tax laws differ from one nation to another. In some countries, the taxes on short-term capital gains are relatively higher than the long-term capital gains. Implementation of crypto tax loss harvesting in such cases will result in short-term capital gains.
• Insufficient Information: If the investor lacks sufficient knowledge of the crypto market and tax laws, implementing the startegy could go wrong. It might result in errors and, ultimately, severe tax penalties.
• Defying the wash-sale rule: Several countries cap capital losses or restrict the compensation for capital gains. This can reduce the efficiency of tax loss harvesting.
• Volatile market: The crypto market is known for its volatility. During such heavy plunges or rallies, identifying capital loss can be difficult. Thus, defying the crypto tax loss harvesting strategy.

How do you report crypto losses on your taxes?

Reporting of crypto losses may vary from country to country. So far, many must have paid heavy taxes on crypto losses. Here are some common tips that could be helpful while reporting crypto losses:

• Maintain a detailed record of the transactions: Keeping a detailed record of the crypto transactions makes it easier to keep the crypto ledger up to date. The documentation aids in accurate capital gains and losses computation.
• Keep tracking the current price: Evaluating capital gain and loss gets simpler by tracking the current price of the crypto asset. The difference is known as a loss if the selling price falls lower than the buying price. The loss in cryptocurrencies is further recognized as a capital loss.
• Taxed with income tax: Several countries include cryptocurrencies income in their respective income tax slab. In this case, if you are wondering how to claim crypto losses on taxes, report the loss while filing the income tax return.

It may be necessary to complete additional forms or provide additional documentation to report cryptocurrency losses. In the event of any uncertainty, it is best to get in touch with a cryptocurrency tax expert. Additionally, they will aid in comprehending any additional rebate that might be available while suffering losses.