The cryptocurrency market is down 46% from its all-time high in May, but astute investors are celebrating falling prices.
Because the IRS classifies digital currencies as bitcoin as property, losses on cryptocurrency holdings are treated very differently than losses on stocks and mutual funds, according to Onramp Invest CEO Tyrone Ross. With crypto tokens, the wash sale rules do not apply, which means that you can sell your bitcoin and buy it back, whereas with a share, you would have to wait 30 days to buy it again.
This nuance in the tax code is absolutely huge for crypto holders in the US.
On the one hand, it paves the way for collecting tax losses.
“One thing smart investors do is sell at a loss and buy back bitcoin at a lower price,” explained Shehan Chandrasekera, a chartered accountant and head of tax strategy at cryptocurrency software company CoinTracker.io. “You want to look as poor as possible.”
The more losses you can accumulate, the better it will be for the investor in the long run.
“You can collect an unlimited amount of losses and carry them over to an unlimited number of tax years,” added Chandrasekera.
Because the wash sale rule does not apply, investors can reap their crypto losses more aggressively than with stocks, because there is no fixed waiting period.
“I see people doing this every month, every week, every quarter, depending on their sophistication,” he said. “You can collect a lot of these losses.”
Accumulating these losses is how investors ultimately compensate for their future earnings.
When an individual goes to liquidate their share of cryptocurrencies, they can use these collected losses to reduce what they owe to the IRS through capital gains tax.
Quickly buying back cryptocurrencies is another key part of the equation. If properly timed, buying the dip allows investors to go back up, if the price of the digital currency recovers.
So let’s say a taxpayer buys a 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 reaped $ 40,000 in losses on previous crypto transactions, he could offset the tax he owes.
It is a strategy that is gaining popularity among CoinTracker users, according to Chandrasekera.
But he cautioned that careful accounting is essential.
“Without detailed records of your transaction and cost base, you cannot verify your calculations with the Internal Revenue Service,” he warned.