Does the IRS take a large chunk of your cryptocurrency income? Maybe you traded one cryptocurrency for another at the right time and withdrew a lot of it in dollars, and now you have found that the IRS wants a share of it. There are several things you can do to reduce your crypto tax burden. Let's explore some of them here.
What are the crypto taxes?
Cryptocurrency is considered "property" for federal income tax purposes. And, for the typical investor, the IRS treats it as a stock asset. As a result, crypto taxes are no different from taxes you pay for any other profit from selling or trading an asset for stocks.
When you buy an asset, whether it's a stock, bond, house, widget, Bitcoin, or other investment, you establish a basis equal to its purchase cost. When selling, compare the sales income with the basis to determine a capital gain or a capital loss. If your income exceeds your basis, you will have a capital gain. If it is reversed, you suffer a capital loss.
You will also need to consider how long you have owned the asset. Depending on the age of your crypto, your gains or losses will be considered "short term" or "long term." This distinction will also play an important role, as you will have to pay crypto taxes.
Short-term gains and losses
When you buy and sell an asset within a 365 day period, you see a short-term capital gain or loss. Short-term income is subject to the same tax rates you pay for regular income, such as wages, salaries, commissions, and other earned income. The IRS has seven tax brackets for regular income, ranging from 10% to 37% in 2021.
Long-term gains and losses
If you buy an asset and sell it after one year, the difference between the selling price and its basis is the long-term capital gain or loss. You will generally pay less tax on a long-term gain than a short-term gain, as the rates are generally lower. There are currently three tax rates for long-term capital gains: 0%, 15%, and 20%. The taxes you pay depend on your income.
So, here are the steps you can take to reduce your crypto taxes.
Engage in Tax Loss Harvesting
If the value of some of your cryptocurrency holdings has fallen, then tax-loss harvesting, where you sell the crypto at a reduced price to realize a loss, can be a great way to lower your overall tax bill. The tax loss harvesting is in no way suspicious or unusual: it is perfectly legal to offset capital gains with capital losses. So if you currently own a cryptocurrency that has fallen in value significantly, it is worth selling it to offset any gains you made earlier in the year (you can also use it to offset up to $3,000 regular income)
Invest for the long term
Since cryptocurrency is generally treated as property by the IRS, the rate of return on capital is lower for investments held for more than a year. Therefore, if you buy crypto and sell it after nine months, the capital gains tax rate will be higher than if you sell it after fifteen months. Of course, you may still find that the volatility of cryptocurrencies means that you will end up with more money in your pocket, even after taxes, by selling in the short term. However, reducing long-term capital gains tax is worth considering when making buying and selling crypto.
Donate Long-Term Crypto Assets to Charities
Crypto assets can be donated to tax-deductible charities. When you donate crypto assets that you hold for more than 12 months to a charity, you receive a tax deduction equal to the asset's fair market value at the time of the donation. At the same time, you don't have to pay capital gains tax on the donated property.
For example, John donates 2 Bitcoin (BTC) to a qualified charity. He bought this BTC for $2000 three years ago. At the time of donation, it was worth $15,000. Here John can deduct $15,000 as a charitable donation on Schedule A and avoid capital gains tax for $13,000 ($15,000 - $2,000). (If John sold 2 BTC and donated the income to a charity, he would have to pay a capital gains tax of $13,000)
Buy and sell cryptocurrency through IRA or 401-K.
When you use your retirement account to buy cryptocurrencies, you can defer paying taxes (or even avoid paying them). All income and earnings generated by the retirement account will revert to the deferred tax account or (in the case of Roth IRAs) with no charges applied to it. This means that your cryptocurrency investment can grow more and more without being hampered by the need to withdraw money to pay taxes. This is a great option for avoiding taxable events and minimizing tax obligations.
Hire a crypto specialized CPA
A good crypto accountant can certainly help you save money on your taxes (and not just cryptocurrencies). While hiring an accountant may seem like an expensive step, their fees can often be paid with a reduced tax bill. Most cryptocurrency investors are not tax savvy and it is definitely worth consulting with someone who is.
Bottom Line
Some of these tips are ones you can put into practice today, like hiring a tax professional, CPA, such as CORE PERFORMANCE. The main conclusion here is that there are ways to reduce your tax liability when it comes to cryptocurrency, and it's just a matter of choosing one or two methods that suit your needs.
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