Falling crypto prices put investors in a 'unique' position to take advantage of a classic tax strategy, says CPA

Cryptocurrency markets have been in a bit a slump.

Bitcoin, the world's largest cryptocurrency, fell 6% in Monday trading, its biggest daily drop since March. It has since bounced back some, and price on the digital currency currently stands at about $93,000, still about a 25% decline from an all-time high of nearly $125,000 in October.

Other prominent digital currencies, such as ether and Solana, have had recent declines as well and, like bitcoin, have now logged a negative return over the past 12 months.

For crypto investors under a dark cloud, some experts say there could be a silver lining: The Internal Revenue Service allows you to use losses on investments you sell to offset investment gains and taxable income.

The rules around this move — particularly as they pertain to crypto — can be complicated, so you'd be wise to talk with a financial advisor or tax pro before making any moves in your portfolio.

But for savvy investors, taking advantage of short-term losses is worth exploring before the end of the year, says Miklos Ringbauer, a certified public accountant and founder of accounting firm MiklosCPA.

"If you have the ability to reduce your taxable income, it's always beneficial," he says. "And crypto is in a unique position."

That's because, at least for now, certain rules that apply to traditional assets, such as stocks and mutual funds, don't apply to digital currencies. Here's what you need to know.

Here's a basic overview of how tax-loss harvesting works. Investments fluctuate in value all the time, and as long as they're still in your portfolio, that usually doesn't mean much for your taxes.

When you sell something you own, however, that's a taxable event. Sell it for more than you paid for it, and you've realized a gain. That means you'll owe capital gains tax on the difference. Profits from an investment you've held for less than a year, known as short-term capital gains, are taxed as ordinary income. Gains from investments you've held for longer are taxed at the more favorable long-term capital gains rates, which can be 0% to 28%, depending on your income and investment type.

Sell an investment for less than you paid, and you've realized a loss. This is where the IRS allows you to use your losses to offset tax you owe on any gains.

Initially, offsets must be like for like: Short-term losses offset short-term gains and long-term losses offset long-term gains. After that, any excess losses can be used to offset the opposite kind of gain.

Then, if your losses still exceed your gains, you can use up to $3,000 of your net loss to negate ordinary taxable income.

Any additional money you have on the negative side of the ledger can be rolled over into the following year indefinitely.

Any loss you realize locks in for the year in which you incurred it, which means you have until Dec. 31 to book losses for tax year 2025. And if you're in a position to roll over losses for future tax years, it's easy to see why "harvesting" them can be a canny move, says Marianela Collado, a CPA, certified financial planner and CEO of Tobias Financial Advisors.

"You're essentially taking advantage of an opportunity for one moment in time," she says. "You have a loss today. Then, if you need to [sell an appreciated investment to] raise cash down the line, you've banked losses from a few years ago."

In other words, if you have some losses now, realizing them gives you flexibility to offset tax you may owe somewhere down the line.

"Paying as little tax as I can today is one of the rules for success," Collado says. "That money is better in my pocket than in Uncle Sam's."'

What constitutes a gain or a loss in a crypto investment can be more complicated than with more traditional assets like stocks or bonds. You may realize a gain or loss, for instance, when exchanging one virtual currency for another. You may want to consult a tax pro if you have a complicated crypto portfolio.

In a more straightforward scenario, say you buy $2,000 worth of crypto and the price falls to $1,000. You plan to hold for the long term and expect it to bounce back to $2,000 and even climb to $10,000 eventually.

If you held on as the price fell to $1,000 and then bounced back to $2,000 you'd have no gain or loss. But if you sold at $1,000 and immediately bought your holding back, you'd end up with the same return, but would have "harvested" a $1,000 loss that you could use to offset gains elsewhere in your portfolio.

With the likes of stocks, mutual funds and exchange-traded funds (even ones that hold crypto) you can't do exactly that. The "wash-sale" rule generally requires you to wait 30 days before reinvesting in whatever you sold — or buying an investment the IRS deems "substantially identical."

That means you can't sell and buy back shares in the same stock, and you can't sell one fund tracking the S&P 500 and reinvest in another one tracking the same index.

This rule doesn't apply to cryptocurrencies, which are treated as property, rather than securities, for tax purposes.

"You can bank your losses and then buy it right back," says Collado. "That's one of the unique aspects of crypto."

However, Ringbauer believes the IRS or lawmakers may take steps to close what amounts to a tax loophole in the future.

"The safest answer is probably it will, at some point, be classified the same as stocks," says Ringbauer.

For that reason, you and your tax pro may decide to err on the side of caution and wait for 30 days to buy anything back, he says. If the rules change, they'd be unlikely to apply retroactively, he says, but the IRS could still invoke the so-called "substance over form" doctrine, the gist of which is, you may still owe taxes if you make moves solely to avoid them, rather than for a legitimate purpose.

"The big question is, is it worth it to me to be the subject in the IRS's audit or court case" should the agency eventually attempt to amend the rules, he says.

Regardless of how you approach it, Ringbauer says harvesting losses where you can is a worthwhile strategy for investors with crypto losses on their books.

"Money in our pocket is always worth more than the unrealized gains and losses," he says. "Having the existing loss in our portfolio gives us the ability to make more educated choices and not just to be stuck with a tax bill. That's tax planning 101."

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