It's been quite a ride for cryptocurrency. In just over a year the value of Bitcoin (BTC) exploded from $4,000 at the beginning of the pandemic to more than $63,000. That's a whopping 1500% increase. However as the saying goes, what the market giveth the market taketh away. A barrage of negative news and developments has triggered a steep selloff in the crypto market.
China's crackdown on Bitcoin mining and crypto trading was big news, and here at home the IRS has made it very plain that cryptocurrency reporting and tax enforcement is a top priority. Just last week it was announced that any cryptocurrency transaction valued over $10,000 is required to be reported like a regular cash transaction. Headlines about the astonishing carbon footprint of Bitcoin are making news. Reports of extremely leveraged holdings are concerning. Also, growing calls in the US and abroad for government-sponsored digital currencies have added more uncertainty in space.
As a result of these developments and more, the cryptocurrency is experiencing a major market correction or "unwinding" as some have labeled it. BTC has lost 50% of its value in the last few weeks. Similar losses have occurred in other crypto tokens. The total value of all cryptocurrency is down over $1 trillion.
If you've sold and taken some profits this year, congratulations. If you are holding cryptocurrency units with unrealized losses, this downturn might be a good time to "harvest" those losses and reduce your overall capital gains tax liability.
Cryptocurrency investments are treated as property for tax purposes much like stocks. Tracking your basis (cost) is critical for each unit or lot of crypto you acquire. Like any asset, when you dispose of cryptocurrency your basis is used to calculate a gain or loss. Most portfolios contain units of crypto acquired at different times, perhaps by different means, each with a different basis. When it comes to calculating your gains and losses, how do you know which specific lot you sold? You choose a costing method or lot identification.
Traditionally traders and accountants used the conservative FIFO (first-in first-out) costing method. However, the IRS currently also allows specific identification methods like LIFO (last-in first-out) or HIFO (highest-in first-out) provided you can specifically track the details of each unit of cryptocurrency and you are consistent with the costing method you use. Using a specific identification method can create important tax planning opportunities.
Fortunately for crypto traders, investors, and tax preparers there are now numerous portfolio tracking services which import all your transaction histories from across multiple exchanges. The software will analyze the different costing methods allowing an investor to visualize and selectively harvest short and long term losses for tax purposes. CryptoTrader.tax TokenTax CoinTracker and ACCOINTING are just some of the names with excellent tax analysis features. Take it from us, these portfolio managers are your best friend!
Do you want to harvest losses but still remain in the cryptocurrency market? It's also worth noting that the wash sale rules governing loss recognition of stocks do not apply to cryptocurrency, at least not yet. So if you decide to selectively harvest some losses in your crypto portfolio to offset current or future capital gains, you can turn around and buy that same cryptocurrency right back again. You "book" the tax loss but you can remain fully invested in the crypto, if that's what you want.
Cryptocurrency taxation can be complicated and data intensive. It is definitely an area where the rules and reporting requirements are still evolving. It is highly recommended to consult with a professional to identify tax planning opportunities and to remain in compliance with changing tax code.
As always at Monadnock Tax Services we are happy to help individuals and families with friendly tax advice and services. Give us a call at (603) 722-0184 or email info@monadnocktax.com