Have you had a great year with cryptocurrencies? Made the right trades at the right time and seen some hefty gains? Unfortunately, come tax season and the IRS is going to want a big chunk of your gains – they are already sending out warning letters!
Given that crypto trading hasn’t been around for too long, there isn’t a lot of clarity around crypto taxes and how they work. Yet, there are a few things that you can do today to minimize your tax liability in a big way. Here are some of the most important ones:
#1 Cut your losses before the year ends – or not
Let’s say you have made significant capital gains selling cryptocurrencies during the year. But you’re currently holding currencies whose value is extremely low. Selling these holdings will trigger a capital loss, and you can use those losses to offset other capital gains and even up to $3000 of ordinary income. You can also carry over remaining losses to the next year.
But what if you don’t actually want to sell your holdings but stay invested for the long term? A simple approach is to just buy back what you’ve sold after a few days. Luckily, cryptocurrencies are classified as “property” by the IRS, which means that the “Wash Sale Rule” that applies to stocks and securities doesn’t apply to cryptocurrency. The Wash Sale Rule prevents traders from offsetting capital gains if they repurchase an investment that was sold for a loss in the last 30 days. Since this doesn’t apply to cryptocurrencies, you can sell your holdings, book your losses, and then buy them back.
#2 Remember your trading fees, they pile up!
This one’s a no-brainer but still gets forgotten sometimes. Cryptocurrency trading fees are nothing but a cost to acquire the crypto, and are therefore treated as a fully tax-deductible. Transfer fees, on the other hand, are not directly related to the cost of acquiring the crypto. So ignore the transfer fees (which are relatively negligible anyway) but deduct all trading fees.
#3 Be a HODLer for at least a year
Holding cryptocurrencies for less than a year triggers short-term capital gains tax which end up being significantly higher than long-term capital gains tax. So it’s usually better to stay invested for a longer period of time.
Of course, you may argue that the volatile nature of cryptocurrencies means that gains are mostly realized over very short periods. A good way around this problem is to use instant crypto credit lines. These allow you to borrow against your crypto assets instead of having to sell them. So you get instant access to cash while staying invested in the long run and avoiding crypto taxes. The only thing to keep in mind is that such credit lines come with interest rates which are much lower than the tax rates but can pile up if you are borrowing long term – something to keep in mind.
#4 Buy crypto using your IRA or 401-K
If you use a retirement account to buy cryptocurrencies, all the capital gains generated from the transaction will come back to the account with tax deferred. In fact, in the case of a Roth IRA, there’ll be no tax liability at all. So you can keep investing in cryptocurrencies over a long period of time, without having to take out money to pay capital gains tax.
#5 Made gains in real estate and lost big on crypto? You are in luck.
It’s important to remember that your crypto capital gains can also be offset against other capital losses. So if you’ve had a bad run at the stock markets (which isn’t improbable, given that the MSCI world index actually went down 10.44% last year), you can use those losses to offset some of your capital gains and reduce your overall tax burden.
#6 Make the world a better place – give to charity!
If there’s some serious money at stake, Charitable Remainder Trusts (CRTs) are a tax planning vehicle that you can use to minimise your tax liability in a big way.
You need to create a CRT and then transfer your cryptocurrencies to the trust. The trustee will then sell the cryptocurrencies at full market value and then reinvest the proceeds from the sale into other income-generating assets. Not only do you not have to pay any capital gains when the asset is sold, but you will also receive a charitable deduction when you transfer the property to the trust. The trust pays you an annuity for the rest of your days, after which the remaining assets go to charity. So you reduce your tax liability and convert your cryptocurrencies into an income-generating asset!
#7 Record everything!
Failure to report crypto transactions can result in a penalty up to $250,000. Given that there are so many transactions taking place in the course of the year, calculating the amount of tax you owe can become complicated. That’s why it’s important to keep all your transactions in an excel file so that you can calculate the cost of purchase easily. If you don’t have perfect record-keeping, it might be a good idea to use crypto tax software that can help you consolidate the data and generate the documents you need.
The bottom line
Take proactive measures to minimize your crypto tax liability. Use these tips early in the financial year so that you can prepare yourself for tax season and keep most of your capital gains. If you are not sure how to prepare your tax returns, hire a competent crypto tax accountant. While this option may be expensive a good accountant can usually make up for the fees by saving you on taxes.
Do you have any questions/tips/tricks? Let us know in the comments below!
Robin Singh is a cryptocurrency tax consultant based in the UK. He is also the founder of Koinly.io – a cryptocurrency tax solution that simplifies capital gains reporting.
Cryptocurrency is a digital currency that uses encryption (cryptography) to regulate the generation of currency and verify the transfer of funds, independently of a central bank. Cryptography is the practice and study of techniques for secure communication in the presence of third party adversaries.
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