Of course there are strategies to minimize how much crypto tax you pay, the key is to understand how exactly crypto is taxed. Maybe you are planning on holding onto your Bitcoin forever – or just waiting for a better exit point. Before you hit the “sell” button, think about how you’re going to deal with crypto taxes because if you sell for a gain, the IRS will want a cut.
To minimize your crypto taxes, keep more of your money and maximize your gains, you first need a basic understanding of how cryptocurrency gains are taxed. Then you can start thinking about ways to reduce or eliminate your tax bill.
Crypto Taxes 101
Cryptocurrency is considered “property” for federal income tax purposes, and the IRS treats it as a capital asset. As a result, crypto taxes are no different than the taxes you pay on any other gain realized on the sale or exchange of a capital asset.
Capital Gains Tax 101
When you purchase a capital asset – be it a stock, bond, house, widget, Bitcoin, or other investment – you establish a basis equal to your cost to acquire it. When you sell, you compare your sales proceeds to the basis to determine whether you have a capital loss or a capital gain. If your proceeds exceed your basis, you have a capital gain. If reversed, you have a capital loss.
Sounds easy, but……..
You’ll also need to consider the time period for which you held the asset. Depending on how long you hold your cryptocurrency, your gains or losses will be considered “short-term” or “long-term.” That distinction will also play a big role in how much you have to pay in crypto taxes.
What’s the difference? When you buy and sell an asset within a 365 day period, you recognize a short-term capital gain or loss. Short-term gains are subject to the same tax rates you pay on ordinary income, such as wages, salaries, commissions and other earned income. The IRS has seven tax brackets for ordinary income ranging from 10% to 37% in 2022.
If you buy an asset and sell it after a year, the difference between the sales price and your basis is long-term capital gain or loss. You’ll usually pay less tax on a long-term gain than on a short-term gain because the rates are generally lower. Currently, there are three tax rates for long-term capital gains – 0%, 15%, and 20%. The rate you pay depends on your income.
Here is the secret sauce and some useful tips to reduce your tax bill:
- Hold the Asset Until Your Short-Term Gains Turn Into Long-Term Gains. If you have the patience and fortitude to keep your crypto for at least a year before selling, then you’ll likely pay a reduced tax rate on any capital gain.
- Offset Capital Gains with Capital Losses. This works by subtracting losses on crypto assets that you sold during the year from taxable gains on cryptocurrencies or other investments that have appreciated in value. There are limits when using this strategy though. When you recognize investment losses, you first must offset losses of the same type. For example, short-term losses first reduce your short-term gains while long-term losses lower your long-term gains. Then, if you have net losses of either type, you can use them to offset the other kind of capital gain. So, for example, if you have excess short-term losses, you can apply them against any remaining long-term capital gain. If you still have a net capital loss available, you can use it to lower your ordinary income. However, you can only use up to $3,000 of capital loss in any given year. The remaining balance rolls forward to the following year to offset future gains or lower your ordinary income by up to $3,000. Don’t try this on your own though, ask for help from your Fuoco Group tax CPA, or your TFG Financial Advisors professional.
- Choosing to sell in a low-income year. In a low-income year, should you have short-term gains, there won’t be as much other income to push you into a higher tax bracket. If you have long-term capital gains, a lower overall income for the year can mean a lower tax rate on those gains too, because the long-term capital gains rate that applies– either 0%, 15% or 20% – is based on your taxable income. So, if you have less taxable income, you’re more likely to have a lower longer-term capital gains tax rate.
- Reduce Your Taxable Income. This means looking at the tax code for tax deductions and credits that can bring your taxable income down. Schedule expensive (eligible) medical procedures, contribute to a traditional IRA or 401(k) plan, put money in a health savings account, or donate cash or property to charity. There are plenty of other tax deductions and credits that you may qualify for, if you itemize. Ask your Fuoco Group tax professional to help you uncover some other opportunities for tax breaks.
- Invest in Crypto in a tax free Self-Directed Individual Retirement Account. With a SDIRA, you either pay taxes later when you have a lower taxable income in retirement or upfront when you contribute to your Roth SDIRA because you have expectations of higher taxes in retirement. This strategy is not for the faint of heart.
- Gifting your cryptocurrency to family members. If that fits with your wealth management goals, it is another way of lowering your crypto tax bill. The IRS allows you to gift up to $16,000 per year per person without tax consequences. The basis in the cryptocurrency transfers to the new owner.
- Donate Your Appreciated Cryptocurrency to Charity. Not only will this result in no capital gains tax, it can also trigger a significant tax deduction you can claim on your tax return. When you donate an asset, you can claim the appreciated fair market value at the time of donation as a deduction against your taxable income. And, if the charitable organization qualifies as a tax exempt 501(c)(3) charity, it won’t need to pay capital gains taxes when it sells the donated cryptocurrency later.
- Bequeath it in Your Estate. When you pass away, the investment will receive a “step up” or increase in basis to its fair market value at the time of your death. This way, your heirs will not need to pay taxes based on your original basis when they sell the cryptocurrency they inherited.
Reach Out To us: Cryptocurrency is still one of the hottest financial topics. The Crypto industry is facing regulation and scrutiny on it’s the climate impact of crypto mining. Statistics show that crypto investors made big profits in the early innings, but despite the fact the the volatile market has seen some investors make fortunes – and others have had fortunes crumble, the crypto game remains robust and there is still $$$$ to be made. Now that you know a bit more about crypto taxes, you can consider which strategies work best for you to minimize how much you will pay on gains to the IRS. We have years of experience dealing with capital gains and losses and reducing our clients’ tax burden, let us put our expertise in tax efficient transactions to work for you. Contact us at 855-542-7537 or CPA@fuoco.com.
