Taxes in crypto: how to turn market drawdowns into savings

Tax-loss harvesting has long been used in traditional finance. Now it is gaining traction in the crypto space, offering a legal way to reduce your tax bill.

Sounds simple – but getting it right means knowing both how markets work and where the rules are heading. And in 2025, the rules are shifting fast.

What is tax-loss harvesting?

Tax-loss harvesting is an investment strategy where you sell assets that have dropped in value to realize a capital loss. That loss can then offset capital gains from other investments – crypto, stocks, or real estate – reducing your total tax liability.

For example: If you made $5,000 selling Ethereum but sold Bitcoin at a $3,000 loss, you only pay tax on the remaining $2,000 net gain.  If your losses exceed your gains, you can deduct up to $3,000 from regular income and carry unused losses forward into the next tax year.

Crypto’s advantage: the wash sale rule doesn’t apply (yet)

In traditional markets, the Wash sale rule* prohibits investors from claiming a loss if they repurchase an essentially identical security within 30 days. But crypto investors have an edge – for now.

*Wash sale – a U.S. tax rule prohibiting investors from claiming a loss if they buy back the same or “substantially identical” asset within 30 days before or after a sale. The rule exists to prevent people from artificially locking in losses while maintaining their positions. It applies to stocks. It does not (yet) apply to crypto, because the IRS classifies crypto as property, not as a security.

Thus, right now – while Bitcoin and other cryptocurrencies are down – you can obtain free tax savings. The scenario looks like this:

1. You sell BTC or other crypto currently below your cost basis.
2. You deduct that loss from gains on other assets (realizing a capital loss for tax purposes).
3. You repurchase the same crypto, restoring your portfolio position.

How to perform crypto tax-loss harvesting

Here’s how it works:

1. Identify underwater positions. Look for assets trading below your cost basis.
2. Sell to realize the loss. This creates a taxable event and locks in your capital loss.
3. Rebuy immediately (optional). For crypto, there is no waiting period under current rules.
4. Document everything. Keep detailed records for tax reporting.

TokenTax suggests prioritizing short-term losses, since short-term gains are taxed at ordinary income rates (up to 37%), while long-term gains receive preferential rates (0%, 15%, or 20%).

When to harvest losses

Year-end has traditionally been the main time for tax planning. But experienced crypto investors harvest losses throughout the entire year.

The reason? Volatility.

Volatility means more chances to portfolio rebalance – and more chances to harvest. If you simply wait until December, all year’s drawdowns turn into missed opportunities.

Tools like Koinly, CoinLedger, and CoinTracker help track unrealized losses in real time. Some investors use thresholds – for example, selling whenever an asset drops 20% or more below cost basis.

Key caveats and limitations

Before you dive in, know the limits:

Rules may change. The IRS could apply the Wash Sale Rule to digital assets in the future.

This does not apply to crypto ETFs. Spot Bitcoin ETFs and similar securities already fall under the Wash Sale Rule.

Your cost basis resets. When you rebuy, your new basis becomes the current market price. Your holding period resets too – potentially making future gains short-term.

Fees and slippage matter. Trading fees and price movement during trades affect your actual savings.

Regulatory outlook: what’s coming?

A loophole this obvious won’t last.

The Treasury and the IRS have repeatedly signaled their intention to extend the Wash Sale Rule to digital assets. The Build Back Better Act proposed this change back in 2021 (it wasn’t passed), and subsequent budget proposals continue to push for it.

Starting January 2025, crypto exchanges are required to issue Form 1099-DA to report transaction activity to the IRS. Notably, this form already includes Box 1i: “Wash sale loss disallowed” – a clear signal that the infrastructure for future enforcement is already being built.

The field signals that the IRS is ready to enforce – it’s just waiting on Congress. Once Congress acts, the reporting infrastructure will already be in place.

Other tax optimization strategies

• Long-term holding. Lower tax rates after 12+ months of holding.
• Donations. Donating appreciated crypto directly to a 501(c)(3) eliminates capital gains tax and grants a deduction at fair market value.
• Crypto IRAs. Tax-advantaged retirement accounts for digital assets.
• Gifting. You can gift up to $19,000 per person tax-free in 2025, potentially shifting assets to family members in lower tax brackets.
• Cost basis optimization (Spec ID). Choosing which lots to sell for better tax outcomes.

While the window is open

Tax-loss harvesting is one of crypto’s last regulatory loopholes. It’s legal, it works, and it’s still available – for now.

But the signs point to this closing soon. Investors seeking to maximize this benefit should act strategically, maintain impeccable records, and watch for legislative developments.

Markets will stay volatile. The question is whether you’ll use the dips – or just watch them.

Disclaimer: This article is for informational purposes only and is not tax, legal, or financial advice. Tax rules vary by jurisdiction and personal circumstances. Consult a qualified tax professional before making decisions.