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The crypto market is down 46% from its all-time high in May, but shrewd investors are celebrating the dip in prices.
Because the IRS classifies digital currencies like bitcoin as property, losses on crypto holdings are treated much differently than losses on stocks and mutual funds, according to Onramp Invest CEO Tyrone Ross. With crypto tokens, wash sale rules don’t apply, meaning that you can sell your bitcoin and buy it right back, whereas with a stock, you would have to wait 30 days to buy it back.
This nuance in the tax code is absolutely huge for crypto holders in the U.S.
For one, it paves the way for tax-loss harvesting.
“One thing savvy investors do is sell at a loss and buy back bitcoin at a lower price,” explained Shehan Chandrasekera, a CPA and head of tax strategy at crypto tax software company CoinTracker.io. “You want to look as poor as possible.”
The more losses you can rack up, the better it is for the investor in the long run.
“You can harvest an unlimited amount of losses and carry them forward into an unlimited number of tax years,” Chandrasekera added.
Because the wash sale rule doesn’t apply, investors can harvest their crypto losses more aggressively than with stocks, because there’s no baked-in waiting period.
“I see people doing this every month, every week, every quarter, depending on their sophistication,” he said. “You can collect so many of these losses.”
Accruing these losses is how investors ultimately offset their future gains.
When an individual goes to liquidate their crypto stake, they can use these collected losses to bring down what they owe to the IRS through the capital gains tax.
Quickly buying back the cryptos is another key part of the equation. If timed correctly, buying the dip enables investors to catch the ride back up, if the price of the digital coin rebounds.
So let’s say a taxpayer purchases one bitcoin for $10,000 and sells it for $50,000. This individual would face $40,000 of taxable capital gains. But if this same taxpayer had previously harvested $40,000 worth of losses on earlier crypto transactions, they’d be able to offset the tax they owe.
It’s a strategy that is catching on among CoinTracker users, according to Chandrasekera.
But he cautioned that thorough bookkeeping is essential.
“Without detailed records of your transaction and cost basis, you cannot substantiate your calculations to the IRS,” he warned.