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Tax Wins from Market Losses: Managing Your Portfolio Through Volatility

Published, 22 June, 2021

Disclaimer: BlockFi does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide--and should not be relied on for--tax, legal, or accounting advice. You should always consult your own tax, legal, and accounting advisors before engaging in any transaction.

Recent market volatility and falling prices for certain cryptocurrencies have raised many questions about how best to manage portfolios. Buy the dip? Stay and HODL? Any investor knows the market can bring highs and lows, and many are looking for ways to ease their anxiety about day-to-day swings.

Yet taxes don’t always come to mind as a way to manage volatility. Although tax season may be over, market downturns in crypto may create a unique opportunity to lower overall tax exposure and maximize tax benefits all year long.

Tax-Loss Harvesting with a Twist: the Immediate Buyback

Let’s start with the basics. Tax-loss harvesting is the strategic selling of an asset to create a capital loss to offset your capital gains. This deduction from losses reduces the amount of gains the government may tax you on. If that sounds confusing, here are some examples to provide context:

An Unrealized Loss is a loss resulting from holding a cryptocurrency that is currently worth less than the purchase price. For example, if you bought Bitcoin at $50,000 and it is currently worth $40,000, the value of your Bitcoin holdings are considered an unrealized loss of $10,000.
Similarly, an Unrealized Gain is a gain resulting from holding a cryptocurrency that is currently worth more than the purchase price.
Capital Losses occur when you sell a cryptocurrency for less than you spent to buy a cryptocurrency. The federal government does not tax your capital losses.
Capital Gains occur when you sell a cryptocurrency for more than you spent to buy a cryptocurrency. The federal government taxes your capital gains (less your capital losses) on a yearly basis.

Since wash sale rules do not apply to many cryptocurrencies, you have the opportunity to sell your cryptocurrencies for a realized loss and then enter a trade to purchase the same cryptocurrencies without waiting for any specific period of time. This strategy gives you the chance to continue to capture upside in the future while locking in a capital loss to recognize against those gains.

The key here is that the government taxes you based on the net of your combined capital gains and losses. That means if you gain $1,000 on an investment, but lose $500 on another, your capital gains will be net $500.

How Does It Actually Work?

Imagine you sold your BTC holdings earlier this year for a capital gain of $10,000. You also have ETH holdings that currently have unrealized losses of $5,000. If you keep your ETH holdings through the end of the year and have no other relevant transactions, you will be taxed based on your $10,000 in capital gains from your BTC sale.

Utilizing the tax-loss Harvesting strategy, you can instead sell your ETH holdings for a $5,000 loss, quickly buy back substantially similar ETH, and then use the realized losses to offset your capital gains from the BTC sale. In this scenario, the $5,000 in capital losses from ETH can offset half of your $10,000 in capital gains from your BTC sale, while maintaining a similar ETH position.

Turning Volatility to Your Advantage

While it may be gut wrenching to watch your portfolio take a dive, we’ve learned that tax-loss harvesting can enable you to use volatility to your benefit. In other words, the bigger the loss, the greater the potential tax savings. There are three things to consider before taking advantage of this strategy:

Take the time to figure out which of your cryptocurrencies had the highest original price at purchase (your “cost basis”), as this will maximize the loss captured
Short-term capital losses can only be used to net against short-term capital gains, and the same applies for long-term capital losses and gains; double check how long you have held your crypto to know which benefit you will be able to capture now or carry forward for later years
This strategy applies to cryptocurrencies like Bitcoin, but does not apply to crypto-related securities like index funds

Trading between any cryptocurrencies and stablecoins creates a taxable event, recording realized gains or losses. You can take advantage of trading using funds in your BlockFi Interest Account.

As always, BlockFi recommends seeking an independent and personalized tax professional for financial advice before making any financial decision.

Nothing contained in this announcement should be construed as a solicitation of an offer to buy or offer, or recommendation, to acquire or dispose of any security, commodity, investment or to engage in any other transaction. The information provided in this announcement is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. This announcement is not directed to any person in any jurisdiction where the publication or availability of the announcement is prohibited, by reason of that person's nationality, residence or otherwise.

Neither BlockFi nor any of its affiliates or representatives provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

Digital currency is not legal tender, is not backed by the government, and crypto interest accounts are not subject to FDIC or SIPC protections. Learn more at BlockFi.com.

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Last updated on June 22nd, 2021

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