It has been a rough 2022 for cryptocurrency holders who had to face the collapse of luna and its associated stablecoin terraUSD, the meltdown of several digital-asset exchanges, and a brutal financial winter that cut the market value of all coins and tokens to $800 million from the January high of $2.4 trillion. With the year coming to an end, U.S. investors–most of whom are likely to be sitting on losses – have some room to optimize their tax situations and get ready for the upcoming filing season.
Anyone following crypto knows how volatile the market can be. Forbes CryptoAsset & Blockchain Advisor looks at the universe of viable crypto assets with proprietary analysis and insider crypto knowledge to guide you to the best choices.
Below are some strategies and best practices you can follow before the end of the year to save on taxes and have a smoother filing experience in April.
Harvest Tax Losses
Tax-loss harvesting involves selling underwater crypto assets, realizing a tax loss and buying back the same asset to maintain your position. Considering the current state of the crypto markets, loss harvesting is a very effective tool to reduce your upcoming tax bill.
For example, Chris purchased 1 bitcoin (BTC) for $50,000 at the beginning of the year. It is now worth $20,000. Instead of continuing to hold the coin, Chris can sell it for $20,000 and buy it back to maintain his position. This sale makes the previously unrealized loss realized. Chris can use this realized loss of $30,000 ($50,000 – $20,000) to reduce his 2022 income or carry forward the benefit to future years.
Continuing with the example above, if Chris has $40,000 worth of stock gains in 2022, he can fully use the $30,000 harvested loss to shelter most of the $40,000 gain. Thanks to tax loss harvesting, he will only end up paying federal tax on $10,000 of ($40,000 – $30,000) capital gains . If Chris doesn’t have net capital gains on his other investments for 2022, out of the total $30,000 harvested loss, he can only use $3,000 to reduce his other taxable income for the year. However, the benefit is not lost. He can carry forward the remaining $27,000 ($30,000-$3,000) capital loss to future years to offset future gains.
Another thing to note is that the wash-sales rules that affect equities are not applicable to cryptocurrency because it is treated as property by the IRS. This means that you can sell your underwater positions to harvest tax losses and buy them back within a reasonable period of time (for example, within a week) at a lower price if you want to maintain the position. If you were to do this for your stock portfolio, you’d have to wait at least 30 days for the IRS to let you book the loss.
Donating cryptocurrency to charities is one of the rare situations where you can get two tax benefits at once. December is a great time to donate and lock in tax benefits for the tax year.
By donating cryptocurrency to charities:
- You get to bypass the capital gains taxes on appreciated cryptocurrency holdings
- You get a charitable-contribution deduction on Schedule A which will help reduce both crypto and non-crypto-related taxable income
The amount of deduction you get on cryptocurrency donations depends on how long you held the token. If you donate crypto that you held for more than 12 months, you get a tax deduction equivalent to the market value at the time of the donation.
If the holding period is less than 12 months, your deduction will be the lesser of your cost basis or the market value at the time of the donation.
Note that this benefit is available only if you itemize on your tax return.
Each year, the IRS allows you to gift up to $15,000 of crypto assets to an unlimited number of persons without triggering any tax or reporting obligation for any parties involved. If you haven’t used up your annual gift threshold, this is a good time to gift coins or NFTs to your loved ones.
For example, say you have 1 bitcoin (BTC) purchased at $5,000 and now it’s worth $12,000. If you were to gift this to someone, you will not have to pay capital gains taxes on $7,000 ($12,000-$5,000) worth of gains. The donee will not have to report any income either. There is no IRS reporting requirement either because the value of the gift is less than $15,000.
(If you were to cash it out and gift the dollar proceeds, you will have to pay taxes on $15,000 of capital gains)
Losses Due To Bankruptcies Of Exchanges
You might have funds stuck in BlockFi, Voyager Digital, Celsius Network, or FTX that are currently going through the bankruptcy process. Although most people already consider those funds to be lost, unfortunately, for tax purposes, you can not deduct them against 2022 income because the bankruptcy processes are still in progress.
When a case is resolved, you might be able to take a tax write-off depending on the circumstances. ( How Frozen Crypto Funds Could Generate A Tax Write-off For Investors ). It is highly recommended to consult with a tax advisor before taking deductions related to funds lost in exchange bankruptcies.
If you traded cryptocurrency and NFTs during 2022, this is a good time to gather your records, connect all your wallets and exchanges to reputable crypto-tax software, and reconcile annual gains and losses. Since the majority of cryptocurrency exchanges don’t issue a Form 1099-B summarizing your annual gains and losses, it is your responsibility to accurately calculate them.
It is possible that you may have some coins in the green. If this is the case, smart timing could push the tax liability into 2023. The U.S. tax system works on a calendar year. Taxes related to your finances in 2022 is due by April 15, 2023. Since we are at the end of the year, you can consider selling some of your crypto positions any time after December 31 to smartly push the tax liability to 2023.
This strategy is even more effective if your income tax bracket is going to be lower in 2023 due to a change in career, personal situation (taking a year off from work, for example, or moving to a state with no income taxes) or retirement.
- Consider harvesting tax losses if your crypto positions are in the red.
- Consider donating cryptocurrency to qualified charities to reduce your tax bill.
- Start gathering your records to calculate your annual gains or losses related to crypto.
- Will Your Crypto Trading Lead To An IRS Audit?
- The IRS Is Working On A New Tax Form To Capture Your Crypto Activity
- Large Crypto Losses May Not Become Instant Tax Write-Offs, But Here’s What You Can Do
Disclaimer: Nothing in this article is meant to constitute tax, accounting, or financial advice.