Crypto Tax Loss Harvesting: Ultimate 2023 Guide

Crypto tax loss harvesting can help you pay less tax on your crypto investments. It’s totally legal and many investors do it - but there are some tricky rules you need to know around wash sales - depending on whether you're tax loss harvesting Bitcoin or other cryptocurrencies, or other investments like stocks. That's why we've put together our tax loss harvesting crypto guide to help you pay less tax on your crypto!

What is crypto tax loss harvesting?

Crypto tax loss harvesting is an investment strategy that helps reduce your net capital gains and, in turn, reduce your tax bill for the financial year. When tax loss harvesting, 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 hold it for later gains. Here’s the basics of how crypto tax loss harvesting works:

• You have a capital gain from selling, swapping or spending crypto - for example, Bitcoin.
• You need to pay Capital Gains Tax on that gain, which you don't want to do.
• You have an unrealized loss from crypto in your portfolio as its value has dropped since you acquired it.
• You realize your loss by disposing of your Bitcoin by selling, swapping or spending it.
• You can offset this capital loss against your capital gain.
• You pay no Capital Gains Tax on that gain as a result.
• You may also be able to buy back the Bitcoin you tax loss harvested - so your loss is artificial.

Now let's get into the specifics.

How to tax loss harvest crypto

Tax loss harvesting is easiest to understand with an example, so let's take a look at a couple of different tax scenarios with and without tax loss harvesting.

Liam is a crypto investor who bought 1 BTC for $20,000 and 1 ETH for $1,000 throughout the financial year. The price of ETH rises to $2,000 and the price of BTC falls to $18,000. Liam wants to realize his gain on ETH, so he sells at $2,000.

Without tax loss harvesting, Liam is liable to pay Capital Gains Tax on his $2,000 gain from ETH.

But he doesn't want to do that, so decides he'll tax loss harvest his crypto in order to pay less tax. To do this, Liam sells his 1 BTC, at a loss for $18,000, giving him a $2,000 capital loss. He can offset this capital loss against his capital gain from ETH, meaning he'll pay no Capital Gains Tax on his gain.

We'd mentioned earlier that investors may buy back their asset - but this all depends on where you live, because many tax offices have what's known as a wash sale rule to prevent investors from creating artificial losses.

What is a wash sale?

A wash sale is when an investor sells an asset at a loss and later repurchases the same kind of asset - or a substantially similar asset.

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 back 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 very easily exploited, so many 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 or other assets that were sold and repurchased in a short period of time.

Each country calls this something slightly different - in the USA 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.

Does the IRS wash sale rule apply to crypto?

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.

But, the US wash sale rule currently only applies to assets that are classified as securities - like stocks, bonds and other financial instruments. So for example, if you purchased GME stock, and sold it at a loss and then repurchased it, you wouldn't be able to claim this as a capital loss because of the IRS wash sale rule.

Cryptocurrency isn’t classified as as a security 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 potentially going to change in the near future. In March 2023, Biden's proposed a series of tax reforms for crypto in the Federal Budget, one of which was including crypto in the wash sale rule. It's estimated more than $24 billion could be raised from this change. The budget has only been proposed so far, it still needs to go through the approval process. We'll update this as it progresses.

And a further word of warning, you need to consider the economic substance test. This common law doctrine denies tax deductions when the related transaction lacks an underlying economic purpose - in other words, if you're seen to be deliberately selling assets for the singular purpose of tax loss harvesting, then you're not conducting the transaction for a meaningful or substantial economic purpose. As such, there is the potential risk that these losses would not be deductible against gains.

The IRS wash sale rule is actually pretty unique in this regard, so let’s take a quick look at how other countries deal with wash sales.

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 by dictating which cost basis they must use for assets bought and sold within a short time period. 

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. 

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.

How often should I tax loss harvest crypto?

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. With a crypto tax calculator and portfolio tracker like Koinly - you can track your tax liability and your unrealized losses, allowing you to spot opportunities for tax loss harvesting crypto throughout the financial year.

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. For example, in the US, you can offset up to $3,000 each year in capital losses against ordinary income, allowing you to reduce your overall tax liability.

If you only have losses, you can also carry these forward to offset against gains in future financial years, helping you pay less tax in the future.

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. 

As well as this, if you're buying your asset back, you may end up with an even bigger Capital Gains Tax bill later down the line if you reduce your cost basis at the time you repurchase.

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 some capital loss offset limits.

What we mean by this is that 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 Rules

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 Rules

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 to do so.

Australia Capital Loss Rules

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 Rules

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?

Picking the right cost basis method when tax loss harvesting can make a big difference.

Some countries - like Canada and the UK - have stringent rules around cost basis methods, but other countries - like the US and Australia - allow you to pick your cost basis method.

For example, the IRS allows for several different cost basis methods when calculating your crypto taxes, provided you can specifically identify the assets. 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, LIFO or 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. You can learn more about what is illegal in our crypto tax evasion guide.

What about short vs. long term gains when tax loss harvesting crypto?

In the US, you'll pay a different rate of Capital Gains Tax on short-term gains and long-term gains and this is important because the IRS says you should offset gains and losses of a similar kind against each other in order. So, you'll offset short-term losses against short-term gains first, and long-term losses against long-term gains first and so on. However, if you then have any capital losses remaining, you can use these to offset capital gains of the other type.

This is why it's really important to know how long you've held crypto that you're considering disposing of for tax loss harvesting purposes, as you may be able to make significant savings on your tax bill by getting strategic.

Can I tax loss harvest NFTs?

You sure can - and should! Many investors have significant losses from the NFT market since the hype died down. We've got an entire guide on NFT tax loss harvesting for you to sink your teeth into, including tips on how to dispose of NFTs in illiquid markets.

How do I report crypto capital losses?

This very much depends on where you live - but generally, you'll report crypto capital losses as part of your annual tax return. Even if you have no gains for the year, it's important to report your crypto capital losses, as you can carry these forward to future financial years to offset against future gains. Especially in countries like the UK, this is important as you need to register your losses within 4 years in order to carry them forward.

We've got guides on how to report your crypto gains and losses around the world, as well as guides on how to report with TurboTax, TaxAct, H&R Block, Wealthsimple and more.

• How to report your crypto to the IRS
• How to report your crypto to the ATO
• How to report your crypto to HMRC

Can I offset my crypto capital losses against gains from stocks and other assets?

Again, this depends on where you live - but generally, yes! In the US, you can offset gains and losses of a similar kind (so generally in the same tax rates). So if you have gains from stocks and losses from crypto, you'd be able to offset your crypto capital losses against capital gains from stocks.

Can I tax loss harvest Bitcoin?

Yes, you can tax loss harvest Bitcoin. It doesn't matter on the specific cryptocurrency you're tax loss harvesting - it's all the same from a tax perspective.

Can I claim losses back on crypto?

Yes. You can claim many losses as capital losses to reduce your tax bill - but it depends on the kind of loss. If you've disposed of your asset by selling, swapping, or spending it, you can claim this back as a capital loss on your taxes and offset it against your gains.

However, if you have a loss due to theft or an exchange collapsing, you may not be able to claim this as a capital loss. As well as this, if you have a loss from a wash sale from crypto, you may not be able to claim this as a capital loss depending on where you live.

What’s the crypto tax loss harvesting deadline?

You need to realize your losses (by selling, swapping or spending your crypto) ahead of the end of the financial year (EOFY) in order to offset them against your gains that financial year. The financial year varies depending on where you live, but here's some examples:

Check out our country crypto tax guides to learn more about the rules where you live. 

How do I get started with tax loss harvesting crypto?

Use Koinly.

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.

Koinly makes crypto tax easy. Get started for free today.

The information on this website is for general information only. It should not be taken as constituting professional advice from Koinly. Koinly is not a financial adviser or registered tax agent. You should consider seeking independent legal, financial, taxation or other advice to check how the website information relates to your unique circumstances. Koinly is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of this website.