Guest Post by Bryce Welker, CEO at CPA Exam Guy
Tax season is in full swing and with IRS cryptocurrency regulation being implemented, you want to be sure to file your crypto taxes. One nice thing about claiming your crypto on your taxes is that you can use your losses to offset other capital gains.
Let’s take a look at how you should handle your crypto losses along with some other important items to consider when going through the crypto portion of your taxes.
First of all, if you want any tax advice about filing your cryptocurrency taxes, you might consider taking a look into a CPA (if you are not aware of what a CPA means, check out this article).
You want to be sure that everything you file is accurate, so consider reaching out to a professional CPA who is familiar with cryptocurrency or an automated cryptocurrency tax software service (such as CoinTracker). With Coin Tracker, you’ll have your crypto portfolio in one place so you don’t have to track down every transaction you made throughout the year when it’s time to do your taxes.
Offsetting Capital Gains
When doing your taxes in the United States, the Internal Revenue Service (IRS) says that cryptocurrency is taxed like property. This means that any time you sell or trade your cryptocurrency, you will realize a capital gain or loss.
If you realize a gain, it means you have sold your cryptocurrency for more than you initially paid for it. However, it also means that you have to pay taxes on the amount of your gain. On the flip side, if you sell or trade your cryptocurrency for less than what you paid, then you’re incurring a capital loss. When this happens, you can use your loss as a way to offset any gains you realized from other trades. This includes sales from other assets in your portfolio like stocks or property.
Of course, given the crypto winter we find ourselves in, there are more than enough losses for everyone to partake. This is why it’s smart to file your capital losses on your taxes so you can reduce your total taxable income, which will help save you money when you file.
If your capital losses exceed your capital gains, then you will still have excess capital losses leftover after offsetting all your gains. The resulting capital losses can be used to offset other income, up to $3,000 for the year ($1,500 if you’re married and filing separately). This includes W2 income from your salary that will be reduced from your taxable income!
If you have more than $3,000 in net capital losses, then you can roll the remaining amount forward into the following tax year. It’s important, however, that you remember that before you use your capital losses to offset your income, it has to be used against other types of capital gains.
What This Means for You
To get a better understanding of what this means, let’s take a look at an example. You earned $10,000 through the stock market this year, which is a capital gain. You also lost $10,000 trading cryptocurrency. These two numbers offset one another, so you wouldn’t need to pay taxes on your stock market activities.
Depending on your tax bracket, this can save you from paying quite a bit in taxes. For instance, if you’re in the 25% bracket, the example above would save you from paying $2,500 in taxes (10,000 * 0.25). Also, keep in mind that there are other types of capital gains which your cryptocurrency losses can offset.
No Other Types of Capital Gains
In the event that you have no other types of capital gains, then you would simply subtract your losses from your income. Remember, this is capped at $3,000.
You started the year by doing very well trading cryptocurrencies. In the first half of the year, you managed to make around $4,000 trading your favorite digital currencies. Then, in August, your portfolio was hit pretty hard and you took a loss of $6,000.
At this point, you have a net $2,000 loss on the year, which you can deduct from your taxable income. If you made $60,000 in income on the year, you can subtract that loss, which makes your taxable income $58,000. You have thereby saved yourself $500 in taxes ($2,000 * 0.25).
If you want to take advantage of the capital losses you incurred while trading cryptocurrency, it is an important distinction to consider the impact of wash sales. You already know that a taxable event occurs when you dispose of a cryptocurrency (e.g. sell, trade, etc.). That means if you want to show your losses on your current taxes, you need to trade or sell out of your currency crypto prior to December 31 of the tax year.
By doing so, you are triggering a taxable event which will allow you to realize your loss on paper. From that point, you can file your losses as part of your tax return. Since wash sale rules do not apply to cryptocurrency yet, you can buy back the cryptocurrency immediately as a way to “harvest” those losses.
You cannot perform this type of buyback in the stock trading world. This method is very helpful if you’re wanting to keep your crypto, and is a common tactic employed by tax professionals. Let’s take a look at an example.
Let’s say you bought $3,000 worth of Bitcoin in early 2018. Unfortunately, that investment has taken a serious hit and is now worth $500. Now you’re looking at a $2,500 loss. As a way to take advantage of your loss, you trade your bitcoin for ether prior to December 31 during the tax year. You then immediately trade back the ether for the same amount of bitcoin.
Now, you have the same amount of bitcoin you had prior to making the trade and you show your $2,500 capital loss. As we’ve mentioned, this loss will help offset additional income or gains you show on your taxes.
Note: wash sales do apply to securities, and therefore may apply to some cryptocurrencies (e.g. ICOs) as defined by the SEC. You can still always re-create your portfolio if you wait 30 days before buying back the same assets, while still tax loss harvesting.
Disclaimer: this is not meant as tax advice. For tax advice, please speak with a tax professional.