Crypto tax-loss harvesting: How it works and ways to reduce your tax bill

When you earn a crypto profit, you may have to deal with capital gains taxes. Tax-loss harvesting is one way to reduce those gains, and you can find other strategies in our guide on how to reduce crypto taxes.

For example, CoinTracker’s tax-loss harvesting tool (available on Prime and Ultra subscriptions) can scan your portfolio and spot opportunities for strategic sales. In some cases, this tax-loss harvesting can reduce your capital gains and income taxes for multiple years.

Here’s how crypto tax-loss harvesting works, when it may help, and what to verify before selling.

What’s tax-loss harvesting?

Tax-loss harvesting is the practice of selling assets at a loss to offset taxable capital gains. When you dispose of stocks or cryptocurrencies, you realize a capital loss if the amount realized is less than your adjusted cost basis in the asset.

Capital losses first offset capital gains. If capital losses exceed capital gains, individuals may generally deduct up to $3,000 of net capital loss against ordinary income each year, or $1,500 if married filing separately, and carry forward unused capital losses.

How to harvest crypto tax losses

Crypto tax-loss harvesting isn’t difficult, but there are a few considerations and best practices to keep in mind.

1. Clarify country-specific tax-loss harvest rules

Each country has its own rules for using capital losses. For example, Canada and the United Kingdom have specific loss-restriction rules for quick repurchases, and Australia also scrutinizes wash-sale arrangements. If you trade across jurisdictions, confirm the local rule before relying on a harvested loss.

This article focuses on U.S. federal tax rules. The wash-sale rule is covered separately below.

2. Identify assets currently below cost basis

To figure out which of your cryptocurrencies are underwater, subtract the cost basis per coin (the original purchase price, including fees) from the current fair market value (FMV). Say you bought two Ethereum (ETH) at $2,800 each for a cost basis of $5,600. Today, the FMV of two ETH is $3,400, so your maximum loss potential is $2,200.

CoinTracker can help surface unrealized losses across connected accounts, which can make this step easier. It can also help you estimate the tax effect of selling specific assets, depending on the data available in your account.

3. Dispose of assets to realize a loss

You generally can’t claim a capital loss on a cryptocurrency until you dispose of it for less than your cost basis. Selling or otherwise disposing of the asset realizes the loss for tax purposes, subject to the capital loss limitation rules.

4. Track all transactions for your crypto taxes

For U.S. tax reporting, taxpayers generally need records showing the date acquired, date sold or disposed of, proceeds, cost basis, and resulting gain or loss. Sales and other dispositions are generally reported on IRS Form 8949. Learn more in our guide to crypto tax reporting requirements.

Crypto tax software like CoinTracker can help organize transaction history, calculate gains and losses, and prepare the information needed for IRS reporting.

When should you use crypto tax-loss harvesting?

Tax-loss harvesting is usually most relevant when you have unrealized losses and enough information to estimate the tax impact of selling. In practice, many investors review it before year-end and during volatile periods, when losses may be available to offset gains.

But as a general rule, tax-loss harvesting is most effective at year end (when you have a near-complete picture of your gains and liabilities for the year) and during periods of crypto volatility when prices change fast.

What are the benefits and limitations of crypto tax-loss harvesting?

Before you use tax-loss harvesting to offset capital gains, consider these advantages and drawbacks.

Pros

• Reduce capital gains: If you realize gains on other cryptocurrencies, you can use tax-loss harvesting to limit your taxable profits. Learn more about capital gains tax on crypto.
• Take up to a $3,000 deduction: Whenever capital losses exceed capital gains, you can take up to $3,000 off your ordinary income for the year.
• Carry forward unused losses: The IRS allows taxpayers to carry over any losses exceeding $3,000 into future tax years.

Cons

• Still results in a loss: It may seem like you save money with tax-loss harvesting, but the truth is you’re guaranteeing a loss in value on your crypto. Despite reducing your tax burden, selling crypto at a loss lowers your portfolio’s value, and you could lose out on future gains during market rebounds.
• Increased fee burden: Extra charges from disposing and repurchasing digital assets, including exchange fees, gas fees, increased fees during volatile periods, and price inefficiencies, could outweigh the benefits from your tax reduction. If fees matter to your situation, review the rules on whether crypto trading fees are tax deductible.
• Risk of repurchasing a declining asset: If you decide to repurchase the digital asset you sold for a loss, there’s no guarantee the token will increase in value. Market fluctuations may also lead to an unfavorable re-entry point.

Factors to consider when tax-loss harvesting crypto

If you take your time devising a tax-loss harvesting strategy, you’ll be better positioned to enjoy crypto tax breaks without sacrificing your portfolio. Here’s what to consider.

Income bracket

People with high incomes benefit most from tax-loss harvesting because of the higher marginal tax rates. If you’re already in a lower income bracket, the savings from crypto tax-loss harvesting might not be worth the extra effort and exchange fees.

Timing

Instead of making rash decisions right before December 31, schedule a few times each year to review your estimated year-end taxable income plus projected capital gains. These numbers help you calculate the impact of current tax-loss harvesting opportunities and make informed disposals.

Investment duration matters

Short-term and long-term capital gains can be taxed at different rates, so the holding period on assets you sell may affect the value of harvesting a loss.

Crypto viability

Volatile assets like crypto may offer greater potential for gains, but also potentially larger tax losses when compared to less volatile investment vehicles like index funds. It’s important to track your portfolio and always know your tax positions, so if an investment doesn’t work out you are immediately alert and can take advantage at the right time to lower your tax bill.

Pressure to sell

Selling solely for a tax benefit is not always the right move. Consider your broader tax situation, fees, and risk tolerance, and consult a tax or financial advisor if you are unsure.

Reinvestment opportunities

Before selling crypto at a loss, consider what to do with the capital. Whether you want to repurchase the same asset, buy a different crypto, or put your funds into another type of digital asset, knowing where the money is going helps you decide whether a sale is worthwhile.

Does the wash sale rule apply to crypto?

Under current law, the wash sale rule in IRC section 1091 applies to losses from sales of stock or securities when you buy the same or a substantially identical security within 30 days. Cryptocurrencies do not typically qualify as stock or securities, so repurchasing the same crypto within 30 days generally does not trigger the wash sale rule.

If you sell crypto at a loss and buy it back soon after, you can generally still claim the loss under current law. That said, do not treat this as a free pass to manufacture losses. If a transaction is structured solely to create a tax benefit without a meaningful non-tax purpose, the IRS could challenge the loss under substance-over-form principles.

Congress could extend the wash-sale rule to cryptocurrencies in the future. Digital assets that represent stock or other securities may also raise different wash-sale questions today.

Optimize your crypto tax strategy with CoinTracker

If you want help organizing crypto transactions and evaluating potential tax-loss harvesting opportunities, CoinTracker can help. It can track gains, losses, and income across your portfolio and help you prepare for U.S. tax reporting.

Portfolio-level tracking can help you identify unrealized losses and estimate the tax effect of selling specific assets. That can make it easier to decide whether realizing a loss is worth it in your situation.

Tax time is approaching – are you prepared? Let us simplify your crypto tax journey. Create a free CoinTracker account and let our platform handle the complexities.

Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.