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2018 has been an interesting year for crypto-currency markets. Starting with record highs in January, we have seen a steady decline throughout the year to a point where prices are back to the levels of 13 months ago (~$4,800 on 10th Oct 2017)

While 2017 saw records gains in many portfolios, 2018 is likely to see record losses.

As an investor, speculator or HODLer, decisions must be made if you are going to sell.

As we come toward the end of the tax year, you might consider selling some of your crypto holdings to claim losses and give yourself a tax deduction.

Tax Loss Harvesting

Selling assets at a loss can be a useful tax planning strategy. The losses that have been accumulating throughout the year can be realized to offset against other gains and income, to reduce tax liability.

With stocks and shares, you would need to plan this carefully because of the wash sale rule that disallows losses from any sale within 30 days before and after an acquisition of the identical stock. You would have to sell now and hope it doesn't go up too much in December.

However, since Bitcoin and other crypto-currencies have been categorized as property by the IRS (Notice 2014-21) then these rules likely do not apply.

Economic Substance

Before you act, you need to consider one other issue.

Tax experts point to the Economic Substance Doctrine, IRC Section 7701(o), that disallows tax benefits of a transaction if that transaction lacks any economic substance, or is not for a valid business purpose.

A transaction has economic substance if a) it has meaningful changes (apart from tax) in the taxpayer's economic position and b) there is a substantial purpose for making the transaction. Failing these tests could render the transaction invalid for tax purposes, disallowing your losses, and could even impose penalties on any tax underpayments.

So the question becomes does selling crypto create meaningful changes and is there a substantial purpose? And what does that entail?

Tyson Cross, tax attorney at Cross Law and BitcoinTaxSolutions says that,

There is a tried and true principle of the Economic Substance Doctrine under which a transaction has "economic substance" if it exposes the parties to "market risk."

Meaning that letting your portfolio be subject to unknown market forces should be enough to ensure that the sell and subsequent re-purchase would not fail the doctrine. As for how long your should wait, Cross continues,

Two or three days is probably the shortest amount of time I would recommend, with a week or more being the safest choice for those who want to eliminate the risk of the economic substance doctrine almost entirely.

You should review your portfolio and determine if you want to take advantage of any losses to reduce your tax burden, and if so, that you can do it in a way that would be considered to have economic substance.

Long-Term Capital Gains

Also consider that selling now could reduce any benefits from potential long-term gains you might receive next year. Tax rates for long-term gains, which are assets held for more than a year, are substantially discounted at 0% (up to $38,600 as a single-filer), 15% (up to $425,800) and 20% (everything else). This means you need to consider any difference between the potential long-term gain taxes alongside the tax reduction this year. If prices rise next year, it might be better to wait.

Tax Deduction

Tax losses can also be used to offset other capital gains you might have. For example, if you have gains from stocks or shares over the year. Your long-term losses reduce your long-term gains, short-term losses reduce short-term gains, and then the net long-term gain or loss is applied against the net short-term gain or loss.

If there are more losses than gains, these can be included in your tax return as a tax deduction, up to the value of $3,000. Any remaining losses can be carried forward to the next tax year to reduce future gains or income. This continues until all the losses are used.

Let's look at an example.

Say you own 1 BTC that was purchased back in January at $10,000. If you sold it for $4,800, you would have a short-term capital loss of $5,200. You could then buy it back, perhaps at the same price of $4,800 so you own 1 BTC again. You can declare the $5,200 capital loss in 1040 Schedule D. Let's say you also had $1,000 of short-term capital gains from the stock market. Your gains and losses are combined so you total capital gains is now $0 and you don't have any capital gains taxes. You still have $4,200 capital losses. You can also deduct $3,000 of that against your earned income, further reducing your tax liability. The remaining $1,200 in losses are carried forward into 2019 to reduce future gains or income.

Summary

Crypto-currencies are not currently subject to wash sale rules

Review any re-purchases of crypto to ensure you are not failing the economic substance doctrine

Be aware you could still incur some costs from the difference in buy and sell prices as well as trading fees

Reduce taxable income by up to $3,000 per tax year with excess capital losses, with any remainder carrying forward to future years

Tax loss selling will be reset and reduce the cost basis of your assets so selling the following year could result in increased short-term capital gains

Bitcoin.Tax is the leading capital gains and income tax calculator for Bitcoin and crypto-currencies. You can sign up for free at https://bitcoin.tax/signup.

This post is the opinion of the author and is not financial, tax planning or tax advice. Please speak to your own tax expert, CPA or tax attorney on how you should treat taxation of digital currencies.

A list of self-registered Bitcoin and crypto-currency tax experts can be found at https://bitcoin.tax/cpa.