Bitcoin is synonymous with its four-year cycles and volatility, providing various trading opportunities. Depending on your timing, you could be in for feast or famine, and very few retail investors are ready for either, making plenty of unprofitable mistakes along the way.
A bull market can encourage a lot of risk-taking, risks that can prove costly when the brutal bear market comes around, which can clear anything from 50 – 80% off the market cap in a matter of months.
While Bitcoin holders will tell you that it’s all temporary, it’s only paper losses, and if you don’t sell and wait, you could recoup your fiat losses over a long enough timeframe. Not every Bitcoin investor has the luxury of long-term holdings and might require liquidity.
Leaving them with a decision to eat their losses, which might be harsh, but every cloud has a silver lining, and with the help of tax loss harvesting, it might not be all downside for you and your lousy Bitcoin timing.
What is Bitcoin tax loss harvesting?
Bitcoin tax loss harvesting is a strategy where investors sell Bitcoin at a loss to offset capital gains from other investments, thereby reducing their overall tax liability.
For example, if you sold Bitcoin for $10,000 that you originally bought for $13,000, you would have a capital loss of $3,000. You could then use this loss to offset capital gains from other investments, such as stocks or real estate.
The wonderful thing about Bitcoin versus other assets is that the wash-sale rule does not apply, so you can immediately buy back the Bitcoin that you sold for a loss. This allows you to continue holding the asset while still benefiting from the tax loss.
Bitcoin tax loss harvesting can be a valuable strategy for investors who have experienced losses in the cryptocurrency market. By offsetting these losses against capital gains from other investments, investors can reduce their overall tax liability.
Benefits of Bitcoin tax loss harvesting:
- Reduce your tax liability: By offsetting capital losses against capital gains, you can reduce your overall tax bill.
- Continue holding your investments: Unlike with stocks, you can immediately buy back the Bitcoin that you sold for a loss. This allows you to continue holding the asset while still benefiting from the tax loss.
- Offset future gains: If you have any capital gains in future years, you can use your Bitcoin capital losses to offset them.
Considerations Before Tax Loss Harvesting
If you are considering Bitcoin tax loss harvesting, it is important to speak with a tax advisor to ensure that you are following all applicable tax laws and be cognisant of the following:
- Keep records: You must keep records of all the transactions related to the tax-loss harvesting strategy since you need to prove you’re losses to your tax authorities.
- Determine the capital loss: Calculate the difference between the purchase price and the sale price of the Bitcoin and factor in how much you would need to sell to maximise your tax loss harvesting.
- Timing: Timing is essential in this strategy; you can offset capital gains from the same tax year or carry the losses forward to the next taxable year. It’s up to you or your tax advisor to decide the most efficient time to trigger the tax loss.
- Selling your KYC for Bitcoin for non-KYC: Certain Bitcoiners might take the opportunity to reduce their known Bitcoin position by selling their Bitcoin tracked by an exchange, pocketing the losses and then using the cash to repurchase Bitcoin on non-KYC markets to ensure a private holding.
- On-chain versus custodial Bitcoin: Tax loss harvesting requires you to prove that you purchased/owned that Bitcoin for a certain time period. While it’s fairly easy to ask for an exchange for the records if you’re dealing with custodial Bitcoin, when it comes to on-chain Bitcoin, it becomes a lot more complex to secure those dates, especially if you’re not using coin control, and you’re re-using addresses. While the data is all on-chain, it’s up to you to go through and sift to find those dates and prices.
- Maximum amounts: Find out what the maximum amount is that you can use as a claim per year and if it is worth pocketing the tax loss in your country.
- Keep track of deadlines: The U.S. tax year ends on Dec 31st—even though the filing deadline isn’t until April 15th. If you want to claim losses this tax year, you’ll need to take action before New Year’s Day; while many countries follow this same cycle, you should check with your local tax advisor on your applicable deadlines.
- Method of calculation: Find out which method of calculation applies in your region, be it FIFO (first-in-first-out), LIFO (last-in-first-out), and HIFO (highest-in-first-out), and calculate Bitcoin gains and losses.
Risks involved in Bitcoin tax loss harvesting
Tax-loss harvesting using your Bitcoin is useful if you know how to use it, but it is not a silver bullet and won’t make sense for everyone. There are limitations and trade-offs involved.
- Wash-sale rules: The tax codes around wash-sale rules might prohibit claiming losses on the sale of an asset if a substantially identical asset is purchased within 30 days before or after the sale.
- Short-term vs. long-term gains: Depending on your country, the rate for short-term capital gains, which are gains on assets held for less than a year, will differ from long-term capital gains. It’s up to you to ensure you capitalise on the correct rate and have proof that you can call this claim a long-term or short-term trade.
- Market fluctuations: Bitcoin prices can be volatile and affected by several market conditions, events and regulations locally and internationally. You could plan to harvest your losses today but not lock in the trade, resulting in you waking up tomorrow and being in profit.
- Complexity: Tax laws related to Bitcoin are still evolving, with many legal and tax frameworks currently up for interpretation.
- Lack of knowledge: There might need to be more knowledge or regulatory clarity of the Bitcoin market, and your country’s specific tax laws may lead to mistakes and potential penalties.
Do you take self-custody of your stack?
If you’re new to Bitcoin and have not ventured down the self-custody rabbit hole, what is stopping you? If you’re already self-sovereign, how has the experience been since you took hold of your funds? Let us know in the comments below.
We’re always keen to hear from bitcoiners from around the world.
