The recent crypto market downturn and the upcoming recession fears have led many investors to sell their cryptocurrency positions at huge losses thinking that such losses are «instant tax write-offs» on their taxes.
However, this may not be the case. It could take years to receive the full tax benefit of the loss you incurred in 2022, especially if you are going into an extended period with no gains.
What are capital losses?
A capital loss is realized when you sell a coin or an NFT below its purchase price (cost basis).
There are two types of capital losses: short-term capital losses & long-term capital losses. Short-term capital losses occur when you sell your coin/NFT after holding it for less than 12 months and below its cost. Long-term capital losses occur when you sell your coin/NFT after holding it for more than 12 months and below its cost.
For example, say Sam purchased 1 BTC at $60,000 on December 2021. On March 2022, he sold this BTC for $29,000. Since Sam sold the coin after holding it for less than 12 months, he will have a $31,000 ($60,000 — $29,000) short-term capital loss.
$3,000 limitation on capital losses
According to the IRS, you can deduct a maximum of $3,000 capital loss in any given year to offset your other income and get a tax benefit. Losses in excess of this annual cap gets carried forward to future years.
Going with the example above, if Sam doesn’t have any other capital gains in 2022, he can only deduct $3,000 of short-term capital loss in his 2022 taxes. Sam can carryforward the remaining $28,000 ($31,000 — $3,000) loss to future years. He can use this carried forward loss to offset future capital gains, if he has any.
If Sam doesn’t have any gains in future years, it will take staggering 10+ years ($31,000/$3,000) for Sam to get the full tax benefit of the loss he had back in 2022. Big market drops and recessionary times with no gains for an extended number of years often put investors in this unfavorable situation.
Plan Capital Losses Right To Receive The Full Tax Benefit Today
Planning capital losses right can help you get the full tax benefit of losses sooner without having to wait for years.
Going with the example above, assume Sam had (or expects to have) a $40,000 capital gain in 2022. In this case, he can use the full capital loss of $31,000 in 2022 to offset the $40,000 capital gains. Consequently, he will only have to pay taxes on $9,000 worth of capital gains. The $31,000 large loss is fully absorbed and used in 2022 because Sam has capital gains.
Likewise, by planning and timing your capital losses right, you can accelerate the full tax benefit of the capital loss by sheltering more capital gains faster. If there’s no gains in the horizon and you are about to realize a huge capital loss, you might as well hodle the position expecting a gain down the road.
Think before selling positions with large capital losses. You may not be able to get the full tax write-off in the current year unless you have capital gains.
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