DISCLAIMER: This post is not financial or legal advice and should be considered educational only. It is intended to get you thinking about tax loss harvesting but you should consult other resources and not rely on this post alone for financial planning. Tax liability can vary based on circumstances and it is impossible to cover all possible circumstances in a single post. If this is a life changing amount of crypto and thus a life changing amount of taxes I strongly recommend you retain the services of a CPA.

So what is tax loss harvesting?

Tax loss harvesting is simply selling crypto that you want to continue to hold but which currently has an unrealized loss and then rebuying it. You sell while you are down and then immediately rebuy. That "locks in" the loss while you still keep the crypto and benefit from any future price appreciation.

In the US taxes code gains/losses are either unrealized or realized. Gains/losses are unrealized until you sell/trade/spend a crypto and unrealized gains/losses do not affect your tax liability for the current tax year. So if you are "up $2,000" on your ETH holdings but haven't yet sold/traded it that is an unrealized gained. Only by selling/trading/spending crypto do you make a gain or loss realized and thus reported for the current tax year on your schedule D.

So as a hypothetical situation lets say so far this year you have $20,000 in net realized gains. So when you file your 2021 tax return you will pay taxes on that $20,000. How much will depend on if they are long term or short term gains and your income bracket. Lets assume it is short term gains and you are in the 25% bracket. That means you will be looking at $5K in extra federal taxes (plus whatever your state rate is).

Lets say you also hold some crypto that currently has an unrealized loss (current price is less than purchasing price). For this example you bought 1 BTC at $64,000 (ouch) and right now it is trading at $44,000 so you have a $20,000 loss. You can't deduct that loss from your gains because it is unrealized.

However you could right now sell that 1 BTC for $44,000 lock in a $20,000 loss for the 2021 tax year and then immediately rebuy it so you still have have roughly 1 BTC (you will pay fees which will slightly reduce your holdings unless you have some cash as well). So for the current tax year you had $20,000 in existing net realized gains plus this new $20,000 realized loss resulting in $0 in net realized gains and thus $0 in capital gains taxes due for 2021.

What about the 'wash sale' rule?

This strategy can't be used for stocks because there is a regulation call the 'wash sale' rule in the IRS code section 1091 which says any sale of a security for a loss followed by a buy of the same security within 30 days does not count as a loss. It is as if the sell and rebuy never happened. You can try to tax loss harvest with stocks but you would need to wait 30 days between the sell and rebuy and the stock could gain significantly while you wait making it problematic and risky.

https://www.law.cornell.edu/uscode/text/26/1091

However section 1091 specifically limits the 30 day "wash sale" rule to "stocks and securities" (likely because it was written 60 years prior to crypto currencies). The IRS has ruled that crypto is property not a security thus the wash sale rule doesn't apply to crypto and you can sell and rebuy without any waiting period.

https://www.irs.gov/pub/irs-drop/n-14-21.pdf

Changing section 1091 to cover crypto currencies and other non-security assets would require new legislation. Although that could be done by congress at some point in the future, right now in 2021 it doesn't apply to crypto. The lack of a wash sale rule on crypto is what makes this powerful technique to delay taxes possible.

Can I lock in more losses than I have in gains?

Yes. Any excess losses just roll forward to future years where they can offset capital gains. As an example say you have $20K in gains and you create a $30K loss. First the the loss will offset the $20K in gains resulting in no taxes from trading. Next you can deduct a maximum of $3K against your regular income reducing your taxes from income/wages. Finally the remaining "excess" $7K will roll forward to 2022 to offset any capital gains. If you have no capital gains in 2022 then it would keep rolling forward to 2023, 2024, 2025 until you eventually have capital gains to offset.

Aren't losses limited to $3,000 on your tax return?

No. This is a common misconception and goes beyond tax loss harvesting. Your capital losses are limited to net loss of $3K. That is to say $3K more than your capital gains in a given year not a static $3K. So if you have $100K in capital gains and $120K in capital losses, then the first $100K in losses wipes out all your capital gains, the next $3K you can deduct against your regular income, the last $17K you can't use this year but it rolls forward to future years.

So tax loss harvesting makes my taxes disappear?

No. It merely delays you paying taxes. Someday you will sell that crypto which you sold and rebought and hopefully it will have gone up in price. So when you sell you will have a gain and end up paying the "delayed" taxes as well.

If we look at the example above you bought 1 BTC for $64K and then later sold and rebought it for $44K. You harvested a $20K loss in 2021. However lets imagine in 3 years you sell that 1 BTC for $200K. If you hadn't done the tax loss harvesting you would have a $134K gain ($200K - $64K). If you did the tax loss harvesting you would have a $154K gain ($200K - $44K). Note it is $20K larger gain which is exactly the amount of gains you avoided paying taxes on in 2021.

Wait so if I still have to pay taxes someday how does that help?

Delaying taxes in most circumstances is very financially beneficial. In our example you avoided paying $5K in taxes in 2021 meaning you could buy $5K more crypto this year. That crypto helps to grow your portfolio quicker. Any money not spent today on taxes can be used to improve your net worth.

I would gladly pay the IRS all my 2021 taxes in 2025 if they would let me. There are very few situations where you can legally just delay taxes without interest or penalties which makes this an incredibly powerful technique. Yes someday though you will still have to pay the taxes.

When should I not use tax lost harvesting?

There are some situations where tax loss harvesting could increase your taxes.

1. If your taxable income for the year is less than $40K ($80K if married) you should not harvest to avoid any long term capital gains because they are already taxed at 0%. You can still harvest enough losses to delay any short term capital gains. If you only have long term capital gains and income below $40K ($80K if married) you should not use this strategy at all in the current year.
2. If you currently have a long term realized capital gains that you want to offset and you feel you won't keep the crypto you are harvesting for at least one year after rebuying it. Understand that when you sell and rebuy the crypto you reset the 1 year capital gain clock. So if currently you have a long term capital gain taxed at say 15% (most common) and you harvest a loss to delay paying taxes in 2021 but the crypto you sell and rebuy you only hold for six months then the gain when you sell in 2022 will be taxed as a short term capital gain which could be ~25%. Generally speaking delaying the tax but paying a much higher rate is not a good trade. On the other hand if you hold the "harvested" crypto for a year (or more) after rebuying it then it also would be taxed at the same 15% you avoided meaning no increase in the tax rate.
3. Related to #2 is you aren't sure you will be able to hold for a year after rebuying or just are concerned that you might not. In that case a conservative way to use this is to pay any long term capital gains (lower rate) now and offset just the short term capital gains. You won't delay all the taxes you could but you won't ever be replacing long term gains with short term gains.
4. You anticipate being in a higher tax bracket in the future. Lets say you are a student right now but will have a significantly higher income in the coming years. You would be avoiding taxes at a low rate today for a higher rate tomorrow. That may not be ideal. Another situation is you are currently single but will be getting married soon and your spouse has a significantly higher income than you. Your tax rates filing jointly are likely to increase. The higher and the more stable your income is now the more advantageous this method is. Anything that could cause your income to rise significantly faster than the rate of inflation or cause your deductions to decline in the future is something to consider.

What if I bought crypto at multiple prices?

This can still be used but gets a little more complex. You are allowed to choose the costing method when declaring trades (FIFO, LIFO, HIFO). You need to ensure the costing method you use will sell the crypto with the highest price that usually means HIFO or LIFO costing method. The IRS allows you to pick the method used to select which coins are sold however you need to keep good records and you need to be consistent. If you are using software to assist you ensure it either allows you to pick the costing method or the costing method it uses will result in your high priced coins to be the ones that are sold. See this article on costing methods:

https://cryptotrader.tax/blog/cryptocurrency-tax-calculations-fifo-and-lifo-costing-methods-explained%2C%20LIFO%20)

What about fees?

Exchange fees are a cost to engage in this tax avoidance move. Generally speaking if your losses are small it may not be worth it because exchange fees are usually a fixed percentage. Say your exchange charges 0.35% so 0.70% round trip. Paying 0.70% to delay taxes due to a large loss is likely worthwhile but not for delaying a small loss. In the example above the hodler had bought at $64K and harvested at $44K . If he bought at $45K and harvested at $44K then fees would greatly cut into the potential benefits. In both cases the fees would be $308 (0.7% * $44K) but in the first case paying $308 in fees would allow you to delay $20K in gains while in the second case it would only delay $1K in gains.

What if it keeps dipping?

You can just keep selling and rebuying. In the example above the holder bought 1 BTC at $64K when it dipped to $44K be sold and rebought it. If BTC crashed further to $28K he could just sell and rebuy it again and lock in more losses. Due to trading fees you likely don't want to do this too often but instead on a significant move downward.

Can I do this at anytime?

Yes although you need to have a realized capital gains for the year and an unrealized capital loss to harvest. They also have to be in the same tax year. If you have $20K in realized capital gains this year you would need to sell and rebuy to lock in a loss prior to January 1st. If you waited until after January then that loss wouldn't apply until the next tax year so it wouldn't offset your gains for this tax year. It would be a good idea to review all your gains and losses but realized and unrealized in December to see if there are any last minute harvesting trades to make.

Could this change in the future?

Yes it could. The SEC is currently fighting a case that XRP is a security not property. If they win (which seems unlikely) that could cause the IRS to offer new guidance that not all crypto is property. It is my belief that even if the SEC wins in the XRP case or some other future case any ruling would be narrowly tailored as in "XRP is a security" or "xyz crypto is a security" not that all crypto is a security. If that happens then this post should be re-interpreted to exclude any crypto deemed a security by the IRS however as of today no crypto has been deemed a security.

The other more serious threat would be new legislation. Understand the wash sale rule on securities (stocks) sales was implemented to prevent EXACTLY this type of tax delaying tactic. This technique can be incredibly lucrative. On a long enough timeline I imagine that Congress will eventually pass legislation to close this loophole. They haven't yet though and even once they do it it would be forward looking not retroactive.

What should I tell my CPA or tax preparer?

Since most people don't own crypto your CPA might not actually be aware there is no wash sale rule on crypto transactions. Just point him towards the wording of Section 1091 of the IRS code ("wash sale rule") and the IRS guidance (notice 2014-21) that crypto is property not a security or currency.

Is this tax evasion?

No tax evasion is the willful violation of the tax code to avoid paying tax liabilities. Tax loss harvesting is a tax avoidance technique meaning using the legal limits of the tax code to reduce or delay potential taxes as allowed by current law. Remember tax loss harvesting doesn't erase your taxes it just pushes them to a future year. Also keep in mind if Congress wanted to they could remove this capability by revising the wash sale rule in section 1091 to include assets other than securities.

What about countries other than the US?

I have no idea. You will need to see if your country has something like the wash sale rule and if it applies to crypto sales. Many countries tax crypto similar to the US but it really comes down to the exact laws in your country so don't assume this applies to any country other than the US.

How do I know you are correct?

You don't. The point of this is to be educational and get you thinking on the possibilities. You should do your own research. Here are some other resources:

https://www.forbes.com/sites/shehanchandrasekera/2020/02/19/a-tax-loophole-every-crypto-trader-should-know

https://www.cointracker.io/blog/how-to-make-money-when-your-crypto-portfolio-is-losing-money

https://cryptotrader.tax/blog/cryptocurrency-tax-loss-harvesting

You can find more by googling "crypto wash sale rule" and "crypto tax loss harvesting".