Paying taxes isn’t always the number one item on everyone’s to do list. This is especially true if you have accumulated significant gains from investing in cryptocurrencies. What many investors often don’t consider are the opportunities to actually reduce their tax liabilities from their crypto investing. This article discusses six strategies that you can use to help minimize your crypto tax liability.
Depending on what country you live in, your cryptocurrency will be subject to different tax rules. The questions below address implications within the United States, but similar issues arise around the world. As always, check with a local tax professional to assess your own particular tax situation.
The IRS treats all cryptocurrencies as property and not currency for tax purposes. Just like stocks, bonds, and other forms of property, you incur capital gains when you sell or dispose of your property for more than you acquired it for. The government taxes these capital gains differently depending on how long you held the investment. Because the government wants to incentivize long-term investing, the capital gains tax rate is less for investments that are held for more than a year and more for investments that are held for less than a year. This means that if you bought Bitcoin, held it for a month, and then sold it, your capital gains tax rate would be higher than if you waited to sell it a year later.
Holding your cryptocurrency investments for longer than one year can help cut down on your capital gains taxes.
No, this is not a suggestion to donate all of your hard earned cryptocurrency gains to charity. However, if you gift your cryptocurrency to a family member or a friend, you can partially address your problem with cryptocurrency taxes. In 2018, the IRS allowed U.S. citizens to offer a gift of up to $15,000 without documented proof of the transaction. This is also not a taxable event, so the gift does not trigger a capital gain.
This is a particularly interesting alternative considering that when the recipient of your gift decides it’s time to cash out, that value that’s taxed is based on the market value on that given day. Something to think about as you ponder what to do with your crypto gains.
Tax loss harvesting is a common strategy where you sell your assets that will realize a capital loss. All you need to do is look at your investments and see which ones you bought for more than they are currently worth. By selling at a loss, you can potentially dramatically lower your net capital gains and thus reduce your taxable income. Bitcoin tax calculators have built in tax loss harvesting tools that you can use automatically detect which coins present the most powerful tax loss harvesting opportunities.
Because of the volatility present in the crypto markets, it might often make sense to seek short term gains. However, what if there was a way to “cash out” now but still benefit from the longer-term capital gains tax rate? This is where borrowing against your crypto holding can really pay off and minimize your tax liability.
Selling crypto is a taxable event. Exchanging crypto-for-crypto is a taxable event. Borrowing money against your crypto is NOT a taxable event.
Let’s say you bought $1000 of Bitcoin in June of 2017 and saw that investment grow to $30,000. You would face a $29,000 capital gain if you cash out now. Depending on your yearly income, in this example let’s say it is $60,000, you would face a short term capital gains tax on that gain of 25%, and you would owe $7,250 to the government.
Now let’s say you borrowed against that Bitcoin holding for the year. You received $30,000 cash, and the borrower holds your cryptocurrency. You pay interest on that loan. Now you received that same $30,000 that you did in the first example, but you will be locked into the long-term capital gains tax rate rather than the short-term one. Instead of a 25% tax rate, you would only pay a 15% rate on that same capital gain. You pay $4,350 instead of $7,250. This can have a much more dramatic effect when capital gains are substantial.
Using an IRA or 401-K to defer tax payments is a popular way to reduce tax liabilities. The same is present in the crypto markets. By using your retirement account to purchase cryptocurrencies, you can defer paying tax (or even avoid paying it at all): all the income and gains generated by the retirement account will return into the account with tax deferred or (in the case of a Roth IRA), with no tax applied at all. This means your crypto investment can grow without being hindered by the need to take money out in order to pay a tax bill.
To ensure that you are paying the correct amount of taxes on your crypto capital gains and capital losses, you should keep detailed records for every crypto transaction that you participate in over the year. The data you need to collect for these records includes the date you acquired the crypto, the dollar value, the date sold, and the proceeds from the sale. You need all of this data to properly calculate your cost basis and to report your gains. If you haven’t been keeping a detailed record of your crypto transactions, it could save you a significant amount of time to use a crypto taxes calculator that automatically calculates your cost basis and capital gains liability for you. This is one of the best ways to ensure you are minimizing your crypto taxes.