Crypto Bear Market Opportunities_ Make the Most of a Crypto Downturn

Crypto Bear Market Opportunities_ Make the Most of a Crypto Downturn

In traditional markets, the "wash sale" rule prevents you from selling an asset at a loss and then quickly buying it back. But this is the crypto market.

The crypto markets are in a bear market. There is no glossing over the fact that crypto markets are having a difficult year. However, there is a silver lining that is unique to cryptocurrencies that fiscally savvy investors can use to their advantage.

The term "bear market" is defined as a market that has lost more than 20% in a given year. Bitcoin fell -35% in 2022, Ether fell -43% in 2022, and many other coins have fallen much more.

Assuming an investor has lost money on a crypto position, there is a unique opportunity to profit from these unrealized losses. Let's run through a scenario.

The "wash sale" loophole and the use of tax losses.

Let's assume an investor purchased $50,000 worth of Bitcoin (BTC) and Ether (ETH) in their crypto account and the price of Bitcoin was $55,000 per coin and Ether was $3,500 per coin at the time of purchase. Assuming the investor split the funds evenly between Bitcoin and Ether at the time of purchase, he currently owns 0.45 BTC and 7.14 ETH. The investor held the coins during the bear market and still currently owns 0.45 BTC and 7.14 ETH. However, with a Bitcoin price of $29,000 and an Ether price of $1,900, the current value of the position is $26,616, which equates to an unrealized loss of $23,384.

To realize this loss, the investor can simply sell the crypto positions and the loss is realized. The loss of -$23,384 can now be used to offset taxable gains in other parts of the investor's portfolio where he has made gains. This is known as tax-loss harvesting.

In traditional financial markets, an investor is forced to wait 30 days after selling an asset to reacquire the same asset. If the investor does not wait the 30 days, the transaction is considered a wash sale and the loss cannot be used to offset a gain. So if you bought Tesla stock (TSLA) at a price of $1,200 and sold it this year for $775, you can't buy the Tesla stock again for 30 days if you want to claim the $425 loss.

However, this has not (yet) been included in the tax code for cryptocurrencies. So, in the above case, if the investor wants to continue holding Bitcoin and Ether, he simply buys the same amount of both immediately after selling the position. This does not result in a "wash sale" like traditional financial stocks.

The lack of a "wash sale" rule with cryptocurrencies is a unique advantage for the savvy investor, as cryptocurrencies are incredibly volatile and their value can fluctuate significantly within 30 days. The ability to hold a position while realizing the loss is a great way to increase long-term returns and increase the tax efficiency of a financial plan.

While the market will certainly move around a bit between a sell transaction and an immediate buy transaction, the investor in our example can get the bulk of their position of 0.45 BTC and 7.14 ETH (net of market movement and transaction costs).

Crypto tax losses can offset more than crypto gains

Another note: losses realized in a crypto position can be used to offset tax liability on any realized gain, they do not have to be used only against a crypto gain.

It is important to note that taxation and cryptocurrencies are uncharted territory for many accountants and tax advisors. Although the rules are clear, it is incredibly important to track these transactions. If your crypto custodian does not issue a 1099, or if you hold your cryptocurrencies yourself, tracking your transactions by hand or using crypto tax software is essential.

We all wish that the value of cryptocurrencies would increase forever, but unfortunately that is not the case. Understanding the tax rules for crypto positions can provide a unique opportunity during a bear market and help ease the tax burden for investors willing to put in the work. While there is no guarantee that this rule will not change in the future, for now this is a unique feature of cryptocurrencies and should be taken into consideration when planning your finances.