Portfolio in the red? How tax-loss harvesting can help stem the pain

Crypto investors — particularly those that bought in toward the top of the market in 2021 — may be able to find some salvation through a tax-saving strategy called “loss harvesting,” according to Koinly’s head of tax in Australia. 

Koinly is one of the most widely-used crypto tax accounting firms online. Australian head of tax Danny Talwar told Cointelegraph that while most retail investors are aware of their obligation to pay capital gain taxes (CGT) when they make profits, many are unaware that the opposite holds true and that losses can be used to reduce their overall tax bill by offsetting capital gains elsewhere:

“Most people are familiar with the concept of tax on gains. But, what they’re not doing is realizing that they can recognize that loss on their tax return to then offset against gains.”

Loss harvesting

Loss harvesting, also known as tax-loss harvesting or tax-loss selling is an investment strategy where investors either sell, swap, spend or even gift an asset that has fallen into the red — also known as making a “disposal” — allowing them to “realize a loss.” Investors typically do it in the final weeks of the tax year — which in Australia is right now. Talwar notes the strategy works in many jurisdictions with similar CGT laws, including the United States.

“Countries like the U.K., U.S. and Canada follow very similar capital gains tax regimes to Australia or have a kind of loss harvesting,” he said.

The concept is also embraced by traditional investors in stocks, bonds and other financial instruments. In the crypto world, a loss can be realized by converting it to fiat or just trading for another crypto token on the exchange.

Talwar believes that the surge of new crypto investors over the last few years will likely have produced quite a number of loss-making portfolios, given the current bear market:

“A lot of crypto investors got into the market around 2020 and 2021. What that means is that the majority of these people are actually going to be sitting on losses, so their portfolios are in the red.”

Will it work?

Talwar noted there are specific nuances in each country’s tax regime, such as the treatment of “wash-sales,” which could impact an investor’s ability to benefit from tax-loss harvesting, and suggested that investors reach out to their accountants to see how to best execute this strategy.

“A wash sale basically means you’re selling the same asset and reacquiring it in the same space of time, just to recognize a loss for your tax return.”

This is illegal in some countries or the tax authority could deny the claimant from realizing a tax loss.

Koinly has published guidance explaining how the rules regarding wash sales can differ from country to country.

As a general rule, Talwar suggests that anyone that has a portfolio in the red should be thinking about loss-harvesting:

“The more relevant point is if you’ve made a sale during the tax year and you’ve sold at a loss, there’s basically a benefit there that people might miss out on if they don’t put it in their tax return.”

One “extreme exception” to the case would be if an investor’s portfolio only contains loss-making crypto and nothing else. In that case, they won’t have any gains to offset.

Related: Taxes of top concern behind Bitcoin salaries, Exodus CEO says

“They should talk to their accountant. Do they have other assets that they can offset a lot against? You know, there’s no point recognizing a loss if crypto is your only investment, you have 99.8% of your savings in the bank and you’re never going to invest again.”

Tax authorities playing catch up

Talwar believes that while global tax authorities have made huge strides over the last three years to keep up with the rapidly evolving crypto industry, there’s still a lot to catch up on as more retail investors pile into the market and crypto accessibility continues to rise:

“Three years ago, it was rare for a tax authority to actually have some type of guidance on crypto out there. And, the crypto space three years ago is a completely different beast from what it is now. It’s become a lot easier to buy and sell crypto for everyday investors.”

However, Talwar noted that “not many” tax authorities have yet released guidance on how investors can record and report the use of decentralized finance (DeFi) protocols despite it gaining strong adoption in 2020.

“The UK is probably leading the way in some respects because they’ve just released guidance on decentralized finance. Not many tax authorities have released guidance on DeFi.”