Crypto tax loss harvesting can help you pay less tax on your crypto investments. It’s legal - but there are some tricky rules you need to know.
With the prolonged bull market crypto has been enjoying throughout 2021, many investors are enjoying huge gains from their investments - but the taxman cometh. Tax offices worldwide are sending a clear message that crypto investors need to pay tax on their crypto gains.
Fortunately, there is a way to pay less crypto tax and it comes in the form of crypto tax loss harvesting. Tax loss harvesting existed long before crypto and (in most countries) it’s a completely legal way to minimize the tax you’ll pay on capital gains.
Let’s get into it.
What is crypto tax loss harvesting?
Put simply - crypto tax loss harvesting is an investment strategy that helps reduce your net capital gains and, in turn, reduces your tax bill for the financial year. Here’s how crypto tax loss harvesting works.
Any time you sell, swap, spend or even gift (depending on where you live) a cryptocurrency - the tax office sees this as disposing of a capital asset. Just like if you sold a stock or a rental property. You’ll make a capital loss or capital gain from disposing of this asset. You can calculate this by subtracting your cost basis from the price on the day you disposed of the asset.
If you make a capital gain, you’ll pay Capital Gains Tax on the profit from your disposal. If you make a capital loss, you don’t pay tax on it. In fact, you’ll be able to deduct your net capital losses from your net capital gain for the year. Your net capital gain is the total amount of capital gains you’ve made throughout the financial year, while your net capital loss is the total amount of capital losses you’ve made throughout the financial year.
When you file your taxes as part of your annual tax return - you’ll report both your net capital gain and net capital loss. You subtract your net capital loss from your net capital gain and the amount left is the amount you’ll pay Capital Gains Tax on.
So, where does crypto tax loss harvesting come into it?
Crypto tax loss harvesting is when an investor sells crypto at a loss to create a capital loss to offset it against their capital gains and reduce their overall tax bill. They may then buy the asset back at the reduced price to HODL it for later gains. Let’s look at a quick example.
Erin bought 1 BTC in July 2021 for $32,000. She noticed the price of BTC drops to $30,000 and sells her 1 BTC. She’s made a capital loss of $2,000.
She uses the $30,000 to purchase another BTC and holds it.
Erin has also invested in ETH this financial year. She bought 1 ETH for $2,000 and later sold it. The price of ETH is $3,000 on the day she sells. She has a capital gain of $1,000.
Erin can use her capital loss from BTC to offset her capital gain from ETH - so she’ll pay no Capital Gains Tax on her gain from ETH. She also has another $1,000 capital loss leftover which she can offset against gains this year, or even carryover into future financial years to offset against future gains.
When should I sell crypto for tax loss harvesting?
All investors know the crypto market is volatile and not all your investments are going to reach the moon. Experienced investors use these dips in the market to sell their assets at a loss, knowing they can offset them against their net capital gains. They may then choose to buy that same asset back for the lower price creating an artificial or paper loss.
To know when to sell - you need to track both your realized gains and losses and your unrealized losses and gains. You only have a realized gain or loss the moment you dispose of your crypto by selling, swapping or spending it.
Before this point, you have an unrealized gain or loss. This means the price of your crypto has appreciated or depreciated since you acquired it - but you haven’t yet sold it so you haven’t realized your gain or loss.
By tracking your unrealized losses and your realized gains, you can keep an eye on your taxable gains throughout the year and look for opportunities to create losses to offset them with.
But there’s a catch - the wash sale rule.
Beware crypto wash sales
When we said above that investors may choose to buy the asset back at the lower price - this is because many tax offices have very specific rules to try and stop investors from pursuing artificial losses.
For example, if you had a large Capital Gains Tax bill looming - you could quickly look through your unrealized losses to figure out how many crypto assets you need to sell, sell these to create a realized loss and then buy them all back immediately at the lower price before the market changes again. You don’t really have a loss as you’ve reinvested proceeds into the same asset - so you’ve got the same assets you always did. But you do have an artificial loss you can use to reduce your tax bill. This is known as a wash sale.
This is very easily exploited, so tax offices have put in stringent rules to try and stop investors from creating artificial losses through a wash sale. This is a rule that generally stops investors from claiming a capital loss from cryptocurrencies that were sold and repurchased in a short period of time.
Each country calls this something slightly different - in America and Australia it’s known as the wash sale rule, in Canada it’s known as the Superficial Loss Rule, while in the UK it’s known as the Same Day and Bed and Breakfast Rule.
Let’s take a quick look at how each country deals with wash sales.
US Crypto Wash Sale Rule
The IRS does have a wash sale rule. The US wash sale rule occurs when an individual investor sells or trades an asset at a loss and buys back a "substantially identical" asset within 30 days. If an investor does this - they cannot claim a capital loss.
However, the US wash sale rule currently only applies to assets that are classified as securities - like stocks, bonds and other financial instruments. Cryptocurrency isn’t classified as this by the IRS, it’s classified as property. So right now, the IRS wash sale rule doesn’t apply to crypto. This said - the wash sale rule will apply to crypto related securities like stocks in exchanges.
Before you rejoice - this is very likely to change in the near future. US congress are currently reviewing the tax treatment of crypto to tighten up loopholes like these. We’ll update this article as soon as they do.
UK Crypto Wash Sale Rule
Instead of a wash sale rule, HMRC has very specific requirements for calculating cost basis which effectively does the same thing. The UK uses the Share Pooling cost basis method as standard - this is similar to the Average Cost Basis method.
The ACB method says you’ll pool similar assets together to create an average cost basis. So you’ll have a pool for BTC, ETH, ADA and so on. You’ll then calculate the average cost basis for each of these pools to calculate subsequent gains and losses. Of course, this is easily exploited when it comes to creating artificial losses - even more so than other cost basis methods.
To prevent this, HMRC has two specific rules to prevent crypto wash sales - the Same Day Rule and the Bed and Breakfast Rule.
The Same Day Rule says if you sell and buy (or buy and sell) the same cryptocurrency in a 24 hour period - your cost basis for the trade will be the price you purchased them for that day. So your previously (higher) cost basis won’t count. You can’t create an artificial loss.
The Bed and Breakfast Rule is similar. It says if you sell and buy (or buy and sell) the same cryptocurrency within a 30 day period, your cost basis for the trade will be the price you purchased them for within that 30 day period. Again, this prevents investors from creating artificial losses.
These rules apply to all capital assets - including cryptocurrency.
Australia Crypto Wash Sale Rule
The ATO has a tax loss selling rule for capital assets. The Australian wash sale rule applies when an investor sells an asset at a loss and purchases the same asset with the intention of a tax benefit. Unlike many other tax offices, the ATO doesn't specify an exact time period and instead states there are a number of factors that may constitute a wash sale - it all comes down to intent. If you're considered to be conducting a wash sale, capital losses as a result of these transactions cannot be claimed and offset against capital gains.
The ATO hasn’t specifically stated that these rules apply to crypto - but they are general Capital Gains Tax rules and crypto assets are subject to CGT rules. It's recommended to check this point with your accountant.
In June 2022, the ATO issued a warning to taxpayers advising them not to engage in wash sales - suggesting it will be a focus for them this tax year. The ATO states taxpayers who engage in wash sales are at risk of facing swift compliance action and potentially additional tax, interest and penalties. Assistant Commissioner Tim Loh said, “Don’t hang yourself out to dry by engaging in a wash sale. We want you to count your losses, not have them removed by the ATO.”
Canada Crypto Wash Sale Rule
The Canada Revenue Agency has the Superficial Loss Rule to prevent wash sales. The Superficial Loss Rule prevents investors from claiming any capital losses where an asset has been sold and bought back within a 30 day period. It applies to crypto like it applies to all other capital assets.
How often should I harvest my crypto losses?
Wash sale rules don’t prevent crypto tax loss harvesting entirely. You can - and should - still track your unrealized losses and regularly look for opportunities to harvest capital losses. This is a lot easier with a portfolio tracker. Better yet, with a crypto tax calculator and portfolio tracker like Koinly.
Many investors opt to harvest crypto losses annually. As the end of the financial year (EOFY) looms, they’ll check through their crypto portfolio to identify any unrealized losses they can utilize to reduce their tax bill for that financial year.
But investors who want to make the most of crypto tax loss harvesting make the most of market volatility throughout the year. They track unrealized losses strategically throughout the year and know to buy in the dip.
Of course, you should always be aware of the wash sale rules in your country. So for most investors this will mean selling an asset at a dip and - should you wish to buy the same asset back - ensuring you wait a minimum of 30 calendar days before buying the same asset back.
You need to realize any losses before the EOFY. The financial year varies depending on the country you live in. Any capital losses you realize after the EOFY won’t count towards this year's tax bill, they’ll fall into the following year. In most countries though, you can carry forward losses.
What are the risks of crypto tax loss harvesting?
Provided you stick to the wash sale rules, you don’t need to worry about a visit from the tax office. Crypto tax loss harvesting is legal.
However, it does have some downsides. Lots of sales and purchases of crypto means more transaction fees. For some exchanges this is up to 4% per transaction. So you’ll need to fit this into your calculations to ensure the savings you’re making on your tax bill aren’t being outweighed by the transaction fees.
Additionally, while tax loss harvesting defers capital gains - it doesn’t get rid of them forever. When you later sell a crypto asset you’ve bought back, you’ll still have to pay Capital Gains Tax on it. If you’ve bought at a significantly lower price due to a dip, you may have a larger capital gain when you do eventually sell. This larger capital gain could essentially cancel out the tax savings you made originally.
What are the benefits of crypto tax loss harvesting?
Besides the obvious benefit of paying less Capital Gains Tax - tax loss harvesting crypto comes with a few other perks.
In some countries, not only can you offset your capital losses against your capital gains - you can also offset it against your income. In some instances, this can push you into a lower Income Tax bracket and significantly reduce the amount of tax you pay in an entire financial year.
As we pointed out above, crypto tax loss harvesting doesn’t actually stop you paying Capital Gains Tax on crypto - it just defers it. But the benefit of deferring this is that you’ve got more money to invest each year, giving you more opportunities to seek out crypto gains.
Is there a limit to crypto tax loss harvesting?
Before you decide to sell all your underperforming crypto at a loss - you need to know that there are capital loss offset limits. What we mean by this is each financial year you can only offset a certain amount of capital losses against your net capital gain. This varies depending on the country you live in, but we’ll quickly cover a few countries' capital loss rules.
USA Capital Loss Limit
In the US, there is no limit on how many capital losses you can offset against your capital gains. However, if your capital losses exceed your net capital gains - you can offset a maximum of $3,000 in capital losses against ordinary income. You can carry capital losses forward indefinitely.
UK Capital Loss Limit
The UK has an annual Capital Gains Tax allowance of £12,300 per person. If your net capital gain is higher than this allowance, you can offset capital losses to keep your net capital gain under the £12,300 allowance. There is no limit on the capital losses you can use to do this.
After doing this, if you have more capital losses left over, you can carry these forward to future tax years, but you must register them with HMRC within 4 years.
Australia Capital Loss Limit
You can use capital losses to offset capital gains in Australia. There is no limit, but you must use up your capital losses each year before carrying them forward. So you can’t carry forward capital losses if you’ve still got a net capital gain for that financial year.
If you have more capital losses than you can use in one financial year, you can carry these forward to future financial years indefinitely.
Canada Capital Loss Limit
Canada’s capital loss rules are a bit peculiar. You can only offset half your capital losses in any given financial year, but there is no maximum limit you can offset against gains. This is because you only pay tax on half your capital gains in Canada. So to keep this fair, the same rule applies for your losses.
If you have more losses than you can use in any one financial year, you can carry capital losses forward indefinitely to offset against future gains.
Which cost basis method for crypto tax loss harvesting?
If you’ve bought your crypto at different price points and you’re now trying to sell to create an artificial loss - you need to know your cost basis.
Countries like Canada and the UK have very stringent rules for cost basis for crypto and other capital assets. But other countries, in particular the US, allow for a lot more flexibility.
FIFO (First In First Out) is the most common cost basis method. In this method, you sell your crypto in the order you received it - so the first crypto you acquired is the first crypto you sold.
However, the IRS allows for several different cost basis methods when calculating your crypto taxes. This includes:
- FIFO (First In First Out)
- LIFO (Last In First Out)
- HIFO (Highest In First Out)
- Spec ID (Specific Identification)
US investors should carefully consider which cost basis method will work best for their crypto tax strategy.
For Australian investors, the ATO similarly allows a few different cost basis methods for calculating crypto gains including FIFO, ACB and HIFO. You can learn more about the different cost basis methods in our cost basis guide.
Let’s look at some other quick frequently asked questions around crypto tax loss harvesting.
Is tax loss harvesting crypto a form of tax evasion?
Nope. Tax loss harvesting crypto is legal. But make sure to stick to the wash sale rules in your country to ensure you can actually offset your capital losses.
What’s the crypto tax loss harvesting deadline?
The end of the financial year (EOFY). This varies depending on where you live, but here’s a few examples:
- US Financial Year: 1st January 2021 - 31st December 2021.
- UK Financial Year: 6th April 2021 - 5th April 2022.
- Australia Financial Year: 1st July 2021 - 30th June 2022.
- Canada Financial Year: 1st January 2021 - 31st December 2022.
Check out our country crypto tax guides for yours.
How do I handle short-term and long-term gains when tax loss harvesting?
Good question. In most countries - like the US and Australia - short-term and long-term gains are taxed differently. Short-term gains from assets held less than a year are often taxed at your Income Tax rate. Meanwhile, long-term gains are taxed at a lower tax rate or with a significant discount. In some countries - like Germany - long-term gains aren’t taxed at all!
You’ll need to keep this in mind when calculating your overall crypto tax bill and when identifying unrealized losses to realize. Otherwise you may end up realizing more losses than you needed to due to calculating long-term gains incorrectly. It’s a lot to keep in mind, but it’s easy when you use Koinly crypto tax calculator.
How do I get started with tax loss harvesting crypto?
All you need to do to get started with Koinly is set up your free account and sync all the crypto wallets and exchanges you use. Once you’ve done this, Koinly calculates your short and long-term capital gains, your capital losses, your crypto income and any expenses. You can see all of this in your tax report page in the summary - giving you a complete picture of your tax bill for the financial year.
Not only does Koinly calculate your crypto taxes for you - but you can head over to the dashboard to track your unrealized gains and losses too. You’ll be able to see how each of your crypto assets is performing and identify opportunities for tax loss harvesting.
Koinly sets up the cost basis method based on your location. For example, the share pooling cost basis method for UK users or the average cost basis method for Canadian users. For countries where you have a variety of cost basis methods available, like the US and Australia, Koinly uses FIFO by default. But you can also select the cost basis method you’d like to use in settings.
Finally, when it comes to tax time - just head to your tax report page and pick the tax report you want to download. Koinly offers specific tax reports based on where you live. For example, the IRS Schedule D and Form 8949 for US taxpayers or the HMRC Capital Gains Summary for UK taxpayers.