One question we’ve often received is: how is crypto taxed?
Crypto is taxed similar to stocks and options in many ways, but crypto also has a tax advantage that could reduce your taxable gains significantly in a given year. To help my clients understand this strategy, I put together a quick primer with my best understanding of the taxation of crypto (this is not a definitive guide), but I should note that this is subject to change at anytime. Also, I’m not a tax professional and this is not financial advice, but offered for educational purposes.
Okay, let’s dive in.
When you buy crypto low and then sell high (shame on you for not HODLing), a capital gain is realized. The profit from the sale of crypto is considered a short-term capital gain if you hold for less than a year and long-term capital gain if it was owned for more than a year. If you had any capital gains you are required to claim it on your taxes. Depending on your exchange, you may receive a 1099, but you should report it even if you don’t — because the IRS is cracking down (and you never did look good in orange).
Short-term capital gains are taxed at the same rate as ordinary income (think taxes on your salary) and long-term gains are generally taxed at lower rates — potentially much lower. If you’re married and filing jointly and earn under $80,800.00 a year ($40,400 if you’re single) — you’d owe zero federal tax on your long term capital gains. After that you can earn up to $501,600 a year if you are married filing jointly ($445,850 if you’re single) and your long term capital gains are taxed at 15%.
If you’re married and living off your crypto earnings in Florida — it’s conceivable you could live on $80,800 a year tax free. Assuming you held the crypto for at least year.
So, far, these rules are very straightforward and the same as selling stock or options.
Creating a Tax Loss
Unfortunately crypto and stocks don’t always go up. There is an occasional down day. And you can lose money.
When the market tumbles and you lose money in stocks or crypto, you can sell the asset and create a loss. For example, if you bought GameStop ($GME) for $400 and it drops to $200 — you can sell and write off the loss and use it to reduce your capital gains and possibly even your ordinary income (think salary from your job). Capital losses that exceed capital gains in a year may be used to offset ordinary taxable income up to $3,000 in any one tax year. Net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted — those GameStop losses might outlast you.
But, a word of caution.
If you sell GameStop to create a loss and then you buy back right away — you are subject to wash rules. Wash sale rules prohibit you from claiming a capital loss for tax purposes if you repurchase a stock or security within 30 days of selling it — this rule applies for 30 days before and after the transaction, creating a 61-day window. Not only can you not re-buy the same stock, but you’re also excluded from buying a substantially similar stock or entering into a contract to buy a similar stock (think options contract).
If you buy GameStop again during a certain window (this includes selling puts or buying calls) — you cannot deduct your losses.
Crytpo’s Big Tax Loophole
But, here’s where crypto has a GIANT loophole. Crypto is considered property and not a security — meaning wash rules do not apply (yet), allowing you to use crypto’s volatility to your advantage.
Let’s say you get tired of Dogecoin burning a hole in your wallet and you sell it for $50,000.00 in profit. Good for you, but now you’re on the hook to pay tax on all that money. Now, let’s also assume you bought $100,000.00 in Ethereum right before it crashed by 50%.
Here’s where the tax advantage kicks in.
After Ethereum’s crash, you can sell your Ethereum at a $50,000.00 loss and then immediately buy back your Ethereum so you don’t miss out on the recovery. But, now you have a $50,000.00 capital loss on your balance sheet that you can deduct to offset your capital gain from Dogecoin — this is called tax loss harvesting.
With this strategy, you could potentially offset all your gains in Dogecoin and still not miss out on the recovery in Ethereum. Of course, you’ll have to pay tax on the sale of Ethereum in the future (assuming you make a profit), but we’ll worry about that another day.
Let me know if you have any questions or if I can clarify anything for you.