Cryptocurrency has been one of the hottest topics in the finance world for a while now. Although the market is volatile, studies suggest that crypto investors can still make impressive profits. Many investors are already making a lot of money from buying and selling virtual currencies. If you’ve already purchased some, stay alert and find the best time to cash out. However, you’ll probably need to deal with taxes before that time comes. If you are selling cryptocurrencies for profit, taxes are part of the process.
Cutting down your crypto taxes will help you save more. First, you’ll need to understand the process of taxing crypto gains. Then, you can work around it to keep your losses down. Keep reading to learn a few smart tips that savvy crypto users use to keep taxes down.
Understanding Crypto Taxes
Since cryptocurrency is property, it is taxed as such. If you are a typical investor the IRS will consider it as a capital asset. This means that your crypto taxes are similar to taxes paid on any other gains from the exchange or sale of a capital asset.
When you buy stock, bond, and other capital assets, you establish a basis equal to the cost of acquiring them. When selling, compare your proceeds to the basis.
This way, you can determine if you have a capital loss or capital gain. If you have proceeds that surpass your basis, that’s a capital gain. If they were reversed, that’s a capital loss.
According to Kenneth Boyd from AIS-CPA, another important thing to consider is the duration in which you’ll be holding the asset.
Your gains may be short-term or long-term, depending on how long you intend to hold the cryptocurrency. The distinction may have a major difference in the amount you pay as tax.
Short-Term Capital Gain or losses
When buying and selling assets within 365 days, they are recognized as short-term capital gain or loss. Short-term gains attract the same taxes as salaries, commissions, and wages. The IRS has provisions for seven tax brackets. They apply to ordinary tax from 10 to 37 percent.
Long-Term Capital Gains and Losses
If you purchase and sell your asset after one year, your long-term capital gain or loss is the difference between your basis and sales price. Usually, the sales tax on the long-term gain isn’t as much as on short-term gain.
How to Keep Your Crypto Taxes Low
Once you understand how crypto taxes work, you can start working to keep them low. Here are a few useful tips that will reduce your tax bills:
Wait Until Your Short-Term Gains Become Long-Term Gains
Long-term gains attract lower taxes than short-term gains. If you can, hold your short-term gains until they turn into long-term gains. This is one of the simplest ways to keep your taxes down. Although it takes patience, it is worth the time.
Donate to Charities
Donating your long-term crypto assets to charities may earn you a tax deduction. After donating assets that you have held for over 12 months, you get a tax deduction equivalent to the market value of your asset at the time of your donation.
You don’t need to pay taxes on the capital gains of your donated property.
For example, you can donate 2 BTC to qualified charities. You bought it at $2000 and held it for five years. It may be worth $20,000 when you decide to donate. Here, you can deduct $20,000 as a charitable donation. You can avoid capital gain taxes.
Invest In Self-Directed Individual Retirement Accounts
Investing your crypto in tax-free or tax-deferred Self-Directed Individual Retirement Accounts is another strategy that can minimize your tax bills.
You may pay your taxes upfront after contributing to your Roth SDIRA or later after getting a lower taxable income in retirement.
Offset Your Capital Gains With Losses
Another tip is paying to offset your capital gains with capital losses. It works by subtracting losses on your crypto assets that you sold in the year from the taxable gains on cryptocurrencies and other investments whose value appreciated.
While this strategy is excellent, it has a few limitations. Upon recognizing investment losses, you need to offset losses of a similar type.
For example, your long-term losses reduce your long-term gains, and short-term losses will affect your short-term gains first.
If you have many types of net losses after that, you may use them to offset other types of capital gain. Your excess short-term losses, for example, may be applied to your remaining long-term capital gain.
You can use your remaining net capital loss to lower your regular income. When pursuing this strategy, you may only use up to $3000 of the capital loss to reduce your regular income in any year.
Any remaining balance will be rolled forward to the next year to offset future gains or lower your regular income by up to $3000.
Use the 0% Long-Term Capital Gain Tax Rate
In the United States, the tax code has a 0% tax rate on long-term capital gains. You may be eligible for the 0% tax rate depending on your filing status, how long you’ve kept the crypto you’re selling, and the income you make annually.
Sell In Low-Income Years
While waiting for your crypto gains to go from short to long term, consider a different timing element – selling in a low-income time. Selling in low-income years may help with your taxes for both long and short-term gains.
If your short-term gains are taxed as regular income, you may not have as much other income added to push you into higher tax brackets.
If, for example, you sell short-term assets upon retirement and aren’t collecting wages, your tax bracket could be based on income from the short-term gains.
If you have long-term capital gains, lower overall income through the year could result in lower tax rates on your gains.
Long-term capital gains are taxed at 20, 15, or 0 percent. Therefore, with less taxable income, you may have a low long-term capital gains tax rate.
If you go on early retirement and have enough money to pay for your living expenses until you access cash from your retirement account, you may not have much income through the year.
If so, this is a great time to take advantage of long-term capital gains. You may be able to take advantage of a 0 percent tax rate.
Go to a State With No Income Tax
State-level income taxes can be high. Avoiding them can help save a lot of money. Not surprisingly, your state is interested in your investment gains. Luckily, there are plenty of tax-friendly states.
They may offer no or low-income taxes. This means you’ll pay federal taxes but not much to the state treasury.
If possible, move to a low or no-income-tax state. If you are lucky, you may be able to eliminate all kinds of crypto tax completely. The savings may eventually add up hence helping you keep more of your earnings.
Reduce Your Taxable Income
This tax-minimizing technique is tried and tested. It is about checking tax codes and identifying deductions and credits. You may be able to bring the tax numbers down.
This may include taking care of a costly medical procedure, donating property or money to charity, contributing to a 401(k) plan, or having money in a health savings account.
You may qualify for many other credits and tax deductions. If you have trouble uncovering all the tax breaks, consider seeking the help of a professional.
Bequeath It In Your Estate
Bequeathing crypto assets to be part of your estate is an effective tip for tax minimization as well. When you die, your investment steps up to the fair market value at the point of your death.
This means that your heirs won’t have to pay tax according to your original basis if they choose to sell the inherited crypto.
Thanks to the volatility of crypto, however, your cryptocurrencies may shoot up or down without notice. In case of such occurrences, and the currencies shoot to the moon, your heirs won’t need to worry about a huge tax bill.
After all, the tokens will have come to them with the basis stepped up.
Use Specific Identification Methods (Highest In First Out)
Being able to identify the following IRS criteria should help you pick the highest in, first out. This is a form of Specific Identification technique that helps you calculate crypto gains or losses.
- The date and time of acquiring every unit.
- The date and time that every unit was exchanged, sold, or disposed of in any other way.
- The fair market value and your basis for each unit at the time it was acquired.
- The fair market value of every unit when exchanged, sold, or otherwise disposed of, and the value of property or amount of money received for every unit.
You’ll need reliable crypto tax software to take care of the calculations for you and maintain electronic records of the criteria.
When using HIFO to manage your tax, you’ll be deemed to be selling units for which you paid the highest price. As a result, you’ll have the lowest gains for the taxes, resulting in lower tax bills.
Gift Your Assets to Family Members
You may want to consider gifting your crypto to family members. It may not be the first option that comes to mind, but it is a great strategy for reducing your crypto tax bill.
The IRS will let you gift up to $15,000 per person every year. You can do this without worrying about any tax consequences.
Although the basis will transfer to the new owner, the recipient may earn a low enough income to ensure that they don’t need to pay tax on their appreciated property.
At the very least, they may pay less in taxes than you would if you chose to sell the crypto yourself.
This strategy is only appropriate if it matches your bigger goals for estate planning and you already plan on transferring your wealth. If you are unsure, consider discussing it with your estate planner first.
Roll Over Crypto Profits Into Opportunity Zones
If you are a high-net-worth taxpayer, this strategy may be ideal for you. It could save you a lot of money if you are dealing with lots of unrealized crypto gains. You may save taxes in three ways: tax elimination, tax reduction, and tax deferral.
You’d primarily roll your long-term profits over into a Qualified Opportunity Fund (QOF). The fund would invest your money in areas that the government has labeled as economically distressed.
If you held your investment there for a minimum of five years, ten percent of your initial tax gain would not be taxed. If you had it for a minimum of seven years, an extra five percent of the initial tax gain would be tax-free.
If you held the investment in the QOF for over ten years, you might avoid capital gains taxes on QOF stocks appreciation completely along with the savings from years 5 and 7. This is one of the most incredible opportunities for saving on taxes.
Tax Loss Harvesting
With crypto, you can aggressively harvest tax losses that eventually translate to huge savings. You can then reinvest these savings in your portfolio. Since virtual currencies are regarded as property and not stocks and securities, wash sale rules don’t apply.
This means that you can sell your loss positions to harvest losses for taxation reasons. You can then get back to the same position without necessarily waiting 30 days. You can use your harvested losses to offset crypto gains.
Buy Crypto In Your Life Insurance Policy
Consider buying cryptocurrency in your life insurance policy if you want to pay zero tax on your gains. Buy your coins within an international life insurance policy. You may be able to fund your Offshore Private Placement Life Insurance with your preferred amount.
You can create the equivalent of a traditional IRA or ROTH. You have no limits to contributions or distribution requirements.
After setting up a private placement policy, consider holding it for a few years and then closing it down.
That way, you’ll get tax deferral, just like in a traditional IRA. When you close out the policy, you’ll pay tax on your gains.
If you keep your policy until death, it’ll be passed down to your heirs. You’ll receive tax-free just like a ROTH IRA. Your heirs get the coins at their price on the day of your death, and they don’t need to pay tax on the appreciation.
Give Up Your Unites States Citizenship
This one may be a bit dramatic, but it works. You don’t need to pay the IRS taxes for your crypto gains if you aren’t a citizen of the United States. After giving up your US citizenship, the IRS no longer has any rights over your earnings.
The issue of giving up your US citizenship is complex, and you need to think about it carefully before making a decision.
Citizens of the United States pay tax on their capital and crypto gains no matter where they live. If, for example, you live in Panama but still have a US passport, you still need to pay tax on your gains. The only way to completely get the IRS off your back is by turning in your passport forever.
You may have to pay an exit tax before giving up your citizenship. You’ll also need to have your second passport in hand. When trying to get your second passport, you have two choices. You can earn one by residing in a foreign country over time or buying it from other countries.
Buy Crypto as a Puerto Rico Resident
If you aren’t old enough to get a big retirement account and wish to secure several million dollars in a life insurance policy, moving to Puerto Rico may be a great idea. The US territory has an irresistible tax deal.
If you are a citizen of the United States, you’ll be taxed on your worldwide income. It doesn’t matter where you live. Puerto Rico is the only exception to the rule. Its sourced income isn’t included in the United States under the IRC Section 933.
In Puerto Rico, sourced income is any business income or capital gain that you earn as a resident if it qualifies for Act 20 or 22. Anyone who spends 183 days a year in Puerto Rico is considered a resident of the island.
Puerto Rico is free to come up with its own tax regulations. It can offer independent tax breaks as it is excluded from Federal taxation.
Since crypto is considered property in the United States, it comes with fairly high taxes. With a few strategies in place, you can keep the tax on your crypto gains low or avoid it altogether. If you are tired of the IRS claiming a lot of your hard-earned gains, consider implementing the above tips.
Ken Boyd is an accounting and finance expert at AIS-CPA. He is also the author of several books, including Cost Accounting For Dummies, Accounting All-In-One For Dummies, The CPA Exam For Dummies, and 1,001 Accounting Questions For Dummies.