(Charlene Rhinehart, CPA)
Many cryptocurrencies like Bitcoin and Ethereum skyrocketed to all-time highs in 2021. People who invested before 2021 saw great returns.
But that has not been the case in 2022. Cryptocurrencies have taken a hit, which means you may have to sell at a loss if you sell your assets.
Losses don’t always have to be a bad thing if you know how to turn them into gains on your tax return. We’ll explain how crypto taxes work with tax loss harvesting so you can lower your tax bill this year.
How is crypto taxed?
Crypto market losses can feel like a slap in the face until you find out about tax loss harvesting. This strategy allows you to reduce your tax bill by offsetting capital gains with capital losses. Since the IRS classifies cryptocurrency as a property, the crypto tax rate follows the same capital gains and losses rules that apply to actions.
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Let’s say you invested in bitcoin at $10,000 and dumped your cryptocurrency when it reached $30,000. You would have to pay taxes on the crypto winnings of $20,000. You realize a capital gain when you sell cryptocurrency for a higher price than you originally paid. This initial investment amount is usually called your cost base.
But if you sell cryptocurrency at a lower price than you originally paid, you incur a capital loss. Through tax loss harvesting, your crypto losses can offset your other crypto or stock market gains. If your losses exceed your winnings, you can sustain up to $3,000 in losses to offset your ordinary income. Any additional losses are carried over to the following year. Tax loss harvesting rules make it easier to reduce your tax bill now and in the future.
Can you benefit from a tax-loss harvest?
Before you get excited about reaping tax losses, make sure you qualify.
You must also have realized a loss to be eligible for tax-loss harvesting. Let’s say you haven’t sold any of your cryptocurrencies this year, but you see a big drop in your portfolio. This means that you only have a waste of paper. You have no realized loss until you dispose of your cryptocurrency. Therefore, you are not eligible to take advantage of tax-loss harvesting.
Turn your crypto loss into a tax win
If you have made mega-profits with one cryptocurrency, you can offset your gains with the losses of another cryptocurrency. If you had stock market gains, your crypto losses could also offset those amounts. This allows you to reduce your tax burden.
Let’s say you bought Ethereum for $10,000 in 2020 and sold it for $30,000 in 2022. That’s a capital gain of $20,000. On the other hand, you suffered a loss of $40,000 on your long-term investment in Bitcoin when you sold it. Since your capital losses exceed your gains, you don’t have to worry about paying taxes.
You will also have the option of using up to $3,000 of your capital losses to offset your ordinary income. In this example, you will end up with an excess loss of $20,000. After using the current year’s loss of $3,000, you can carry forward the remaining $17,000 to future years until you have exhausted your basket of losses.
How to File Crypto Taxes
If you sell cryptocurrency in a taxable investment account in 2022, you will be responsible for pay taxes on your profits. You will also need to report your crypto losses if you want to qualify for a tax deduction. You can report your capital gains and losses from your crypto transactions on the IRS crypto tax Form 8949.
You will need to provide the following:
- Name of the cryptocurrency you sold
- Date you purchased your crypto
- Date you sold your crypto
- Price at which you sold your crypto
- Cost Basis
- gain or loss
Your crypto exchange or broker will send you Form 1099, which will contain the details you need to complete Form 8949, so you won’t have to figure out the numbers from scratch. After completing Form 8949, you will need to transfer the required information to Schedule D to determine your capital gain or loss.
Don’t take your crypto tax gains for granted
If you have suffered major crypto losses on paper, now is not the time to complain. You can keep your investments or use tax loss harvesting to reduce the impact of any gains in your portfolio. Decide which strategy best suits your portfolio and prepare for a winning situation no matter what happens in the markets.
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