As the year is coming to a close, investors are looking for ways to curb their tax bills. And for those who hold crypto assets, there may be a lesser-known strategy to do so.
After the crypto market took a major beating in 2022, losing over $1 trillion in market value, many investors used the “tax loss harvesting” strategy to offset their profits by declaring their losses.
But in 2023, the crypto market has started to regain most of the losses and as a result, you could make use of a strategy called “tax gain harvesting” by strategically selling profitable crypto tokens held in brokerage accounts.
How Does “Tax Gain Harvesting” Work?
The Tax Gain Harvesting strategy works for those of you in the 0% long-term capital gains bracket who have owned digital assets for more than a year, said certified public accountant Tom Wheelwright, CEO of WealthAbility.
You should also note that for federal tax purposes, the Internal Revenue Service (IRS) treats digital currencies as property. The general tax principles that are applicable to property transactions can also apply to transactions using “virtual currency”. But that does not mean crypto is subject to all equities rules.
This also means that capital gains and losses need to be reported by investors to the IRS and they will generally have an effect on their taxes.
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What Is Tax Gain Harvesting?
To put this into context, Bitcoin was trading at $37,200 on November 20, gaining over 120% year-to-date. Yet, it is still down over 45% from its all-time high of $69,000 that it reached over years ago on November 10.
According to Wheelwright, some investors now have “built-in gains” on their purchases. And those in the 0% long-term capital gains bracket can effectively sell their Bitcoin, recognize the gain, and buy it back immediately. The accountant says this can be done because the wash-sale rule does not apply to crypto losses or gains for any assets.
The IRS disallows a loss for other assets if investors buy a “substantially identical” asset within the 30-day window before or after the sale
This move bumps up your ‘cost basis’, which is the amount that you will say that you paid for the Bitcoin when you sell it in the future.
If the prices continue to rise and you sell the holdings once again at a later date, the higher cost basis means your future profits will be comparatively smaller.
Is Tax Gain Harvesting A Wiser Strategy?
If you’ve owned the Bitcoin in question for a period of one year or less before spending or selling it, then any profit returned is considered short-term capital gains that are taxed at your ordinary income rate.
On the other hand, if you have held the said cryptocurrency for more than one year, then any profit is considered long-term capital gains that are subject to tax rates applicable to long-term gains.
Jeff Rose, the founder and CFP of Good Financial Cents, says that tax gain harvesting is a wiser strategy for those who don’t fall in the bracket of high-income earners, as it is an opportunity to secure those crypto gains “without getting dinged by the taxman”. He says the strategy allows investors to sell at a gain and pay no tax, whereas tax loss harvesting defers future tax.
Christopher Alexander, the chief analytics officer of Pioneer Development Group, explained that if investors sell and immediately repurchase the crypto asset, their future capital gains are calculated at the new value of the crypto when they purchased it.
He also gave an example where an investor bought BTC at $18,000 – the lowest price of 2023 – and sold the asset to repurchase it at $36,000 – its current price. Then Bitcoin doubled in price over the next year and they sold it at $72,000 per BTC. This means the investor will only have to pay taxes on the $36,000 gain they made, effectively avoiding paying taxes on the $18,000 worth of gains made during the initial sale.
He said the strategy can be very effective if the investor makes less than $44,625 in annual income or if they are in a higher bracket but have large amounts of crypto or use an aggressive tax strategy.
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How To Know Your Capital Gains Bracket?
For 2023, there is a 0% long-term capital gains rate for single filers with a taxable income of $44,625 or less and $89,250 or less for married couples filing taxes jointly.
This figure is based on the “taxable income” metric, which is significantly lower than gross earnings. You can calculate your taxable income by subtracting the greater of the standard or itemized deductions from your adjusted gross income.
However, the 0% long-term capital gains brackets are much higher for 2024. Single filers will have a taxable income of $47,025 or less and for married couples filing jointly the amount is set to be $94,050 or less.
