Many cryptocurrencies like Bitcoin and Ethereum skyrocketed to all-time highs in 2021. People who invested prior to 2021 raked in great returns.
But that hasn't been the case in 2022. Cryptocurrencies have taken a hit, which means you might have to sell at a loss if you dispose of your assets.
Losses don't always have to be a bad thing if you know how to turn them into wins on your tax return. We'll break down how taxes on crypto work with tax-loss harvesting so you can slash your tax bill this year.
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How is crypto taxed?
Crypto market losses can feel like a slap in the face until you discover 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 property, the crypto tax rate follows the same capital gains and loss rules that apply to stocks.
Let's say you invested in Bitcoin at $10,000 and disposed of your cryptocurrency when it reached $30,000. You would have to pay taxes on crypto gains of $20,000. You incur a capital gain when you sell cryptocurrency at a higher price than you originally paid for it. That original investment amount is typically referred to as your cost basis.
But if you sell cryptocurrency at a lower price than you originally paid for it, you have a capital loss. Through tax-loss harvesting, your crypto losses can offset your other crypto or stock market gains. If your losses exceed your gains, you can take up to $3,000 worth of losses to offset your ordinary income. Any additional losses are carried forward to the next year. The tax-loss harvesting rules make it easier to slash your tax bill now and in the future.
Can you benefit from tax-loss harvesting?
Before you get too excited about the idea of tax-loss harvesting, make sure you qualify.
First, you can only use tax-loss harvesting in a taxable investment account. If you have cryptocurrency in a self-directed IRA, you won't be able to enjoy the benefits of tax-loss harvesting.
You also must have a realized loss to qualify for tax-loss harvesting. Let's say you haven't sold any of your cryptocurrency this year but see steep declines in your portfolio. That means you only have a paper loss. You don't have a 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 victory
If you earned mega-profits from one cryptocurrency, you can offset your gains with losses from another cryptocurrency. If you had stock market gains, your crypto losses could also offset those amounts. This allows you to reduce your tax liability.
Let's say you bought $10,000 worth of Ethereum in 2020 and sold it for $30,000 in 2022. That's a $20,000 capital gain. On the flip side, you took a $40,000 loss 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'll also get a chance to use up to $3,000 of your capital losses to offset ordinary income. In this example, you'll end up with an excess loss of $20,000. After using the $3,000 loss in the current year, you can carry forward the remaining $17,000 to future years until you've used up your basket of losses.
How to file crypto taxes
If you sell cryptocurrency in a taxable investment account in 2022, you'll be responsible for paying taxes on your profits. You'll also need to report your crypto losses if you want to snag a tax deduction. You can report your capital gains and losses from your crypto transactions on IRS crypto tax Form 8949.
You'll have to provide the following:
- Name of the cryptocurrency you sold
- Date you bought your crypto
- Date you sold your crypto
- Price you sold your crypto for
- Cost basis
- Gain or loss
Your crypto exchange or broker will send you Form 1099, which will have the details you need to complete Form 8949, so you won't have to come up with the numbers from scratch. After you fill out Form 8949, you'll have to transfer the required information to Schedule D to determine your capital gain or loss.
Don't take your crypto tax wins for granted
If you suffered major crypto losses on paper, it's not time for a pity party. You can hang on to your investments or use tax-loss harvesting to reduce the impact of any gains in your portfolio. Decide which strategy works best for your portfolio, and set yourself up for a winning situation no matter what happens in the markets.
