Generate capital losses to offset capital gains — for US taxpayers
Cryptocurrencies, a bi-product of the emerging blockchain technology contains an attractive tax reduction property. As this space develops and matures, it’s possible regulators will make adjustments to the law. However, at the moment, cryptocurrency owners can lower their tax burden by artificially creating capital losses.
For example, Peter buys one bitcoin for $50,000. One week later the price drops to $30,000. Peter sells the bitcoin for $30,000 and then repurchases it for the same price, creating a loss for $20,000. This loss can offset other capital gains that were realized. This concept is not new, and is forbidden for stocks by the wash sale rule.
A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days of the sale (either before or after), you purchase the same or a “substantially identical” investment. The wash sale rule was established by the Internal Revenue Service (IRS) in order to prevent taxpayers from being able to claim artificial losses in order to maximize their tax benefits.
In the example above, if Peter then sells the bitcoin for $75,000, Peter has realized a capital gain of $45,000 (75,000–30,000 = $45,000). This gain is then reduced by the 20,000 loss resulting in a net 25,000 capital gain. In this scenario, nothing is gained by selling the bitcoin at 30,000 since had Peter not sold it, the gain would still be 25,000 since the cost basis would remain at 50,000 (75,000 sale price –50,000 Purchase price = 25,000 capital gain).
A beneficial situation is where this generated 20,000 loss is offsetting realized capital gains from a different transaction. Once the losses are used to offset this other transaction, it wont be available to offset Peters’s bitcoin purchase for 30,000. So ultimately Peter will pay taxes when selling the bitcoin with a cost basis of 30,000. However, Peter may choose to sell the bitcoin in 4 years from now, and as a result has benefited by deferring this previous 20,000 capital gain tax liability (which was offset by the generated loss) for 4 years, or even longer. This tax reduction strategy is another form of tax deterrence, similar to a 401k retirement account. Tax deference is the most common strategy used by accountants and financial planners to reduce a taxpayer’s tax liability.
This article is for information purposes only, and should be used in conjunction with your personal tax accountant’s guidance.