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Harvesting Cryptocurrency Losses

By Patrick Lundergan, CFP®

As we near the end of another good year for domestic equities, many investors find themselves facing substantial capital gains taxes. Generally, if you wish to minimize capital gains tax, you should sell securities with a loss to offset those gains – doing this strategically is called tax-loss harvesting. A potential downside to this strategy is that losses are disallowed if the investor purchases back the same security within 30-days of the initial sale, effectively eliminating the ability to recognize the losses on their taxes. This rule, called the wash-sale rule, forces an investor to get out and stay out if they want their loss to count. Cryptocurrency, however, is an exception to the rule for this year and this year only.

Bitcoin hit its all-time high in November of this year at just over $68,000. However, after weeks of decline, Bitcoin’s price stands just below $47,000. While this is still well above Bitcoin’s January price of $30,000, the volatility has left some people seeing red in their crypto portfolios. The following insights will help answer what we can do before year-end. 

The IRS defines cryptocurrency as a capital asset subject to capital gains rates, like a stock.  In 2021 you can sell cryptocurrency at a loss and immediately re-enter the position without disqualifying the loss.  This loophole is the only one of its kind for investors who want to recognize losses without the penalty of staying out of their positions for 30-days. Investors should consider this a viable planning strategy before the IRS implements wash-sale rules on all cryptocurrencies in 2022.

Those with losses that exceed their realized capital gains can also take advantage of the unlimited tax loss carryforward. Any loss that exceeds capital gains in a given year can be used to offset $3,000 worth of income until the total loss is exhausted. Simply put, you can harvest an unlimited amount of losses and carry them forward to an unlimited number of tax years. Although this is true for other capital assets, digital currency is our only way to avoid the wash-sale rule in 2021.

The tax landscape is constantly changing and evolving, especially with digital assets such as cryptocurrency. We are not CPAs, tax accountants or attorneys and do not give legal or tax advice. We are fortunate to work with excellent tax and legal professionals and are happy to provide a recommendation if needed. We encourage all our clients to reach out to us with your questions and concerns. We are happy to be your first call to help you determine if you need to seek out additional expertise.

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Weekly Market Recap

Weekly Market Recap 2021-05-21Download

Weekly Recap:
Equities were mixed last week. In the US, traditional defensives rose,
including real estate, healthcare, and utilities. Technology stocks were mixed, while cyclically sensitive sectors were lower. Small and midcap indices were also down on the week, while major international indices finished higher.

Despite some day to day volatility, bond markets finished close to where
they started. Benchmark 10y US Treasury yields ended the week 1bp lower,
while 30y yields fell 2bp on the week. Investment grade credit spreads were
stable, keep corporate and muni bond prices essentially unchanged.

After setting a new pandemic-era high during the previous week, oil pulled
back on concerns that supply from Iran could return to the market if
sanctions are eased.

Cryptocurrency markets experienced wild price swings coupled with service outages at multiple exchanges after China signaled it would increase
regulatory oversight of crypto mining. Bitcoin finished the week down by
nearly 30%, and extended the selloff over the weekend.

Forward-looking economic news was positive: residential building permits
remained strong, initial jobless claims fell to fresh pandemic lows, and the
Conference Board’s Index of Leading Economic Indicators (LEI) rose to an all-time high on a y/y basis. See the Chart of the Week for a time series

Albion’s “Four Pillars”:

*Economy & Earnings – GDP growth was +6.4% annualized in Q1 2021, and is forecast to accelerate to +8.1% in Q2. Meanwhile, EPS for the S&P 500 turned positive y/y in Q4 2020 and will rise significantly y/y in Q1 2021 as the economy laps the onset of the pandemic.

*Equity Valuation – the S&P 500’s forward P/E of 22x is above the historical average, and long-term valuation metrics like CAPE (cyclically adjusted P/E ratio) suggest that compound annual returns over the coming decade are likely to be in the single digits. That said, lower equity returns may be justified in the context of ultra-low yields on alternatives like bonds and cash.

*Interest Rates – Rates remain low by historical standards despite recent
volatility, supporting equity valuations and lowering borrowing costs.

*Inflation – After staving off deflation early in the pandemic, the Fed has
communicated tolerance for short periods of above-target inflation. A
cyclical bump in inflation may occur in 2021 as pent-up demand is released, testing the Fed’s resolve, but we do not expect higher inflation to persist.

Weekly-Market-Recap-2021-05-21Download
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FAQ: Bitcoin 101

Bitcoin, and more broadly cryptocurrencies, are seeing increasing news coverage. This has left many wondering: “What is bitcoin and how does it work?” For those trying to better understand bitcoin and cryptocurrencies, here’s our understanding on a handful of frequently asked questions:

What is bitcoin?

Bitcoin is a digital “currency” that can be used to purchase goods and services (only at select locations, for now), or held as a store of speculative value. There are many differences between bitcoin and traditional currency, but the principal difference is that bitcoin is not issued by a government or regulated by a government entity.

Where did bitcoin come from?

This is where it gets a bit mysterious. Bitcoin was created by “Satoshi Nakamoto”, an unknown individual or group of individuals. Under this pseudonym a white paper was circulated in 2008 that first described the concept for a transparent, visible peer-to-peer payment system authenticated by a vast network that does not require the presence of a third party middleman – such as banks or other financial institutions. By combining cryptography and unique software protocols, Satoshi Nakamoto originated a payment system that allowed participants to transact directly with one another.

How is it possible to make currency transactions without banks?

Bitcoin transactions have been made possible with the encryption technology underpinning cryptocurrencies known as “blockchain.” Blockchain is a global Internet-wide distributed network that is at its core a decentralized accounting ledger recording every bitcoin transaction. The blockchain ledger is shared by way of an extensive network and the information therein is validated by network “miners” every ten minutes by solving mathematical puzzles using very fast computers and high amounts of electricity. This network validated ledger is crucial as it ascribes proof of ownership to digital assets like bitcoin. If the ledger proves ownership, participants can have trust when making transactions.

Tying together the concept of bitcoin and blockchain, think of it this way – the bitcoin “coins” themselves are simply seats within the aforementioned blockchain ledger. Anyone can buy into or sell out of this ledger at any time – with no prior consent, and with little-to-no fees. Therefore, when buying a bitcoin you are essentially acquiring one of a number of fixed slots within this ledger. You leave the ledger by selling your bitcoin to someone else who wishes to buy in.

If I want to buy bitcoin, how would I make a purchase? Do I need to buy a whole coin?

There are many exchanges out there that allow participants to deposit US dollars (or other widely accepted global currencies) directly from traditional bank accounts in exchange for bitcoin. Some cryptocurrency exchanges also have mobile apps allowing participants to buy bitcoin anytime, anywhere.

Additionally, participants need not buy a whole bitcoin to participate. The smallest unit of bitcoin, a “satoshi”, is the size of one hundred millionth of a single bitcoin (0.00000001 BTC).

What are the risks to purchasing and holding bitcoin? The current price seems high!

It depends on the type of risk one is referring to. Let’s start with general cybersecurity threats. Cryptocurrency exchanges, including those which trade bitcoin, have been hacked before, and will likely be hacked again. Perhaps the most notable example was in 2014 when “Mt. Gox”, the largest bitcoin exchange at the time, failed as a direct result of hackers and vast bitcoin theft. Security surrounding cryptocurrency exchanges have notably improved since Mt. Gox’s failure. Individuals can use bitcoin digital wallets and vaults that are encrypted with a secure network key which dramatically reduces the possibility of being hacked.

Another key risk worth touching on is the possibility of loss of capital for those speculating on its price. Bitcoin has experienced a monumental run as of late. There are a variety of opinions and market variables as to why this has occurred. Will this price rally continue, or crash? Nobody knows for sure. However one way to think about it is, by design, bitcoin was given a finite supply – determined at inception to be 21,000,000 bitcoins – and we are now seeing growing awareness leading to rising demand. This basic supply / demand dynamic may help describe, at least at some level, recent price moves in bitcoin. That being said, just because more cryptocurrency enthusiasts are now entering the market seemingly pushing up prices does not mean everyone should take a position. With a greater understanding of bitcoin – both its potential opportunities and risks – paired with careful holistic wealth advice, more educated decision making can be made on potential bitcoin / cryptocurrency participation.

We hope that this FAQ provides a helpful introduction to bitcoin / cryptocurrencies, and perhaps even sparks your desire to want to learn more. The investment team at Albion Financial Group is well versed in bitcoin / cryptocurrencies and blockchain technology. Please reach out to us at 801-487-3700 or info@albionfinancial.com if we can answer your bitcoin, investment, or financial planning questions.

Disclaimer: Information provided is for educational purposes only. This is not a recommendation to buy or sell any security or cryptocurrency. There are significant risks associated with cryptocurrency that are unique and must not be taken lightly. It is critical that you perform your own due diligence prior to engaging in any buy or sell transaction. The value of bitcoin, or any cryptocurrency can, and may, ultimately go to zero.