What is tax-loss harvesting?
Tax-loss harvesting is a legal investment strategy that helps reduce your overall capital gains for the financial year, and as a result, can reduce your taxes owed.
In crypto, this strategy is played out by investors who sell crypto assets they’ve held at a loss to lower the amount of capital gains accrued in the financial year.
In some regions, disposing of crypto assets via a sell, swap, spend or loan constitutes a capital gains tax event. If the value of your crypto asset at the time of disposal is higher than the cost basis, this will incur a capital gain. If the value of your crypto asset at the time of disposal is lower than the cost basis, this will incur a capital loss.
In regions that recognize capital losses within crypto activity - when an investor chooses to sell their crypto asset at a loss, they can use this loss to offset against their capital gains, thereby potentially reducing their tax bill.
Here’s an example:
Bob buys 1 ETH at $4,300. He holds it for a period of time and then decides to sell it at a value of $3,300. In this scenario, Bob has made a capital loss of $1,000.
In the same financial year, Bob also buys 50 SOL for $5,000. SOL’s value goes up from $100 to $200. Seeing this increase, he decides to sell and Bob has now made a capital gain of $5,000.
Bob can use his capital loss of $1,000 to offset the capital gain of $5,000. He will now only pay CGT on the remaining $4,000.
What’s a wash sale?
“This is genius!”, you may be saying. “Why doesn’t everyone do this, all the time and then just buy back the asset for cheap?!”.
Enter: wash sale rules. A wash sale is classified as when an investor who capitalizes on market dips and sells an asset for a loss, only to buy it back almost immediately. The investor will have the same assets they went into this process with, only now they have a handy way to claim a capital loss. Sounds great, doesn’t it? Tax regulators think so too.
Many tax regulatory bodies across the world have established rules which prevent wash sales from having an impact on an individual’s tax return. In Australia and the US, this is known as the wash sale rule. In the United Kingdom, it goes by the very fancy term of the ‘Bed and Breakfast’ rule (or the Same Day rule), whereas in Canada it’s known as the Superficial Loss rule.
In Australia the wash sale rule applies to a 61-day period, 30 calendar days before the sale and 30 calendar days after the sale. Capital losses as a result of matching transactions during this time period can’t be claimed and/or offset against capital gains.
It’s important to research your particular region’s regulation on this matter so you can make sure your tax loss harvesting efforts aren’t futile.
Okay, so how exactly do I tax loss harvest?
The first step is to decide what inventory method (First In First Out, Highest In First Out, Last In First Out etc) you’ll use to calculate your cost basis. The various types of inventory methods can impact your tax return differently, so it’s best to work with a local tax professional to decide what’s most suitable for you.
After you’ve chosen what inventory method you’ll be using, you’ll then need to track all of your crypto transactions in order to calculate the overarching capital gains and/or losses you’ve made throughout the financial year. This is where we can help!
If you import your data into the Crypto Tax Calculator platform, we’ll be able to help you aggregate all of your short and long term capital gains, losses, income and expenses. Using our main dashboard, you’ll also be able to view any unrealized gains and potential tax-loss harvesting opportunities in the ‘Winners and Losers’ section.
Key Takeaways:
Tax-loss harvesting is a strategy of selling crypto assets for less value than you initially bought them, and using this capital loss to offset any capital gains.
Be cautious of wash sale rules in your region! There will likely be a period of time in which you won’t be able to buy back the crypto asset you’ve sold AND claim a capital loss on the initial purchase.
Tax-loss harvesting is a strategy that can be implemented throughout the entirety of a financial year as markets fluctuate, rather than a one-off event nearing tax deadlines.
Crypto Tax Calculator can help you aggregate all of your short and long term capital gains, losses, income and expenses. You can use our platform to help you build the most beneficial tax return for your situation.
Case Study: The Terra Situation
What happened:
In the week of May 9th, 2022, the Terra ecosystem saw a huge downward spiral.
It began with deposits into the Anchor platform, a yield generation product built on the Terra ecosystem, dropping from $14 billion to as low as $3 billion. The offerings of Anchor included a juicy APY yield, which initially attracted a lot of UST holders to lock their investments up in the platform.
Before the decline began, Anchor held over 75% of UST’s (Terra’s stablecoin) entire circulating supply. A lot of these holdings were put down to the desirable promised returns from Anchor’s yield programs. It made a lot of sense for investors in a ‘stablecoin’ to use that supposedly less volatile coin to earn a substantial yield on a regular basis.
When deposits into Anchor started dropping off, it signaled a loss in confidence in everything that Terra was. As deposits continued to come out of Anchor, there was increased selling pressure to both pinnacles of the Terra ecosystem: UST and LUNA. This selling pressure resulted in sharp and sustained drops in price to both UST and LUNA. What was most concerning was that UST, the algorithmic ‘stablecoin’ upon which LUNA was built, was meant to stay pegged to the value of the US dollar. When UST started falling below $0.90, and got to a low of even $0.21, panic ensued. People began asking, how could a stablecoin which was algorithmically designed to be pegged to the US dollar fall this low, unless the entire system was broken? As more questions were asked, more panic ensued, prices continued to fluctuate and so on and so forth the cycle went (and at the time of writing, continues to go).
What impact did this have:
Investors have lost portfolio value up to the millions, possibly even billions. This tweet’s author showed proof of their Luna holdings being worth over $2.9M USD before the situation unfolded, and now being at a worth of just $1,000 USD. In this case, obviously, a huge loss has been incurred.
What does crypto tax have to do with any of this:
Let’s say you were the individual writing that tweet, whose investment in Luna dropped from $2.9M USD in value to a mere $1,000 USD in value. That’s a $2,899,000 reduction in value if the user decides to sell their Luna holdings at this point.
At the time of purchasing their Luna holdings, it cost the individual $1M USD. Using this $1M as a cost basis, they would be able to prove a capital loss of $999,000 USD if the user sold at this point where their holdings are only worth $1,000. This substantial loss could be used to offset any other capital gains they’ve made in that particular financial year, or in some regions, could be carried forward to offset any future gains made.
Please be advised that the information provided on this website is general in nature and is not tax, accounting, or legal advice. Ensure to consult with your accountant for your individual situation. For th newest update on this topic, please check here.