The crypto market witnessed one of the worst days in history with a one-day decrease in bitcoin price of nearly 50 percent. Economic risks from pandemic coronavirus crunches and liquidity crunches have sparked major bitcoin sell offs and other cryptocurrencies. Altcoins and DeFi networks have similar problems too. However, not all hope is lost. A downturn such as this poses unique opportunities for tax savings, especially in the cryptocurrency room. A brief tax code lesson could help you save thousands— or more— when you’re filing your 2020 taxes.
Crypto Losses Are Not Realized Until You Sell
Knowing that reporting losses for tax purposes are different from having a loss in your portfolio is extremely necessary. The tax code requires you to exclude the perceived losses in most situations only. Many of your crypto-currency positions When you sell your position, these losses become realized and you can deduct the losses on your taxes.
For example, let’s say David bought 1 bitcoin (BTC) at $10,000 on January 15, 2020. On March 11, 2020, the price of BTC drops to $3,000. In financial terms, he has lost $7,000 worth of value. ns are currently in the dark. You can not subtract pure market value declines in the positions for tax purposes because they are unrealized. From a tax point of view, though he has lost a profit of $7,000, he has not recognized this loss because he has not yet sold the place. Unless he were to hold the position without selling, despite making a financial loss, he would NOT be able to recover any losses for tax purposes.
Tax Loss Harvesting Is Crucial
Converting unrealized losses into actual losses helps David to gain a deduction while filing his taxes for 2020. He needs to sell his shares, which are at a loss, to accept his losses. He also has an option to buy back into the same positions at a much cheaper price (without losing ability discount losses) because, under existing guidelines, the regulations on wash sales do not apply to cryptocurrencies. Any crypto tax tools will help you get tax losses.
Watch Out For Margin Liquidation Tax
It is super necessary to know some of your losses to mitigate unforeseen capital gains resulting from liquidation margins. If you’re a margin trader, your original profit is likely to have been liquidated because of big price swings. When you trade on high leverage, even minor volatility in the market will cause liquidations, which can result in taxes on capital gains. For eg, on February 10, 2020, when BTC’s price was $9,000, suppose Jennet deposited 1 BTC into her margin account. Originally she purchased this BTC for $1,000 in 2010. She sets the leverage to be 5X such that her notional buying power is 5 BTC (1 BTCx 5) or 45,000 dollars (9,000x 5). Let’s presume Jennet, with her full notional worth of $45,000, goes long on ether. The exchange will liquidate her original 1 BTC deposit at 5X leverage if the $45,000 balance goes down by 20 percent (notional value down to $36,000).
If the BTC price is $9,000 at the time of liquidation, she will end up having to pay taxes on capital gains amounting to $8,000 ($9,000-$ 1,000). It is a tricky situation where Jennet owes taxes on capital gains even though he loses his investment.
Loss Carryforwards To Offset Future Taxes
Under the tax code, you can report capital losses of up to $3,000 on your tax return. The good news, though, is that losses of $3,000 can be carried forward indefinitely into future years. Those losses can be used to reduce potential profits from crypto and product transactions. To gain from this provision you must recognize your losses as explained above.
Knowing and performing these easy tricks before the end of the year will help you get a substantial tax break when you file for taxes. The tax code, for the most part, just cares for your actual losses, not the economic impact of your real world loss. Using this to your benefit in lowering taxes.