To talk about cryptocurrency taxes, we need to go back to 2014 when the IRS issued guidance on cryptocurrency and classified it as property or assets, not as actual currency.
What that meant was that Bitcoin and other cryptocurrencies were to be treated much like investments, stocks, or real estate for taxation purposes.
So, what does this tax stuff mean for crypto?
Simply put, trading crypto or undertaking other transactions/activities involving your cryptocurrencies will trigger taxable events. As such, you are obligated, as a taxpayer, to report your capital gains and/or losses when filing your tax returns.
Remember here that failure to file or properly report crypto capital gains could get you into serious trouble.
If you are a cryptocurrency investor or trader, then no doubt the IRS’ recent move to send letters to 10,000 individuals has got you thinking: is there a way I can avoid huge tax debt when trading cryptocurrency?
Luckily, the answer is yes; you can trade crypto and still avoid paying huge taxes to the IRS. But before we look into the details of that, here is a reminder of what a taxable event is in relation to cryptocurrency.
So, what triggers a taxable event in cryptocurrency?
You will likely trigger a taxable event almost every time you engage in a cryptocurrency-related activity. Here is what the IRS considers taxable events in crypto:
- Cashing out or trading crypto into USD or other fiat currency
- Crypto-to-crypto trading (buying ETH with BTC)
- Using crypto to obtain goods and services
- Any earning/income received in cryptocurrency is taxable, including mining or wages paid in bitcoin, etc
On the other hand, what does not constitute a taxable event?
You do not trigger a taxable event:
- If you buy crypto with USD or fiat money
- If you donate crypto to charity or a tax-exempt NPO
- If you gift crypto to someone else
- If you make a transfer of cryptocurrencies on exchanges or between
Let’s get to minimizing that crypto tax debt
As previously stated, purposely evading taxes could get you in a lot of trouble. However, if you are a cryptocurrency trader, and want to avoid huge tax debts or just have lower taxes, then there are a number of perfectly legal ways to help you achieve that goal.
Here, the strategy should be to minimize your capital gains. To do so, try out any of the following ways, all of which may be utilized by professionals.
1. Not just a misspelling: Hodl
This is perhaps the easiest strategy you can adopt to avoid those huge taxes on your capital gains. Hodling means you hold the asset long-term (more than a year, specifically) and so avoid actions like trading or selling that trigger capital gains.
If you buy an asset and hold it long-term, you pay a reduced capital gains rate of 20%, as opposed to the 37% every time you trade, sell or exchange crypto-to-crypto in the short term.
2. Losses aren’t always bad: Tax Loss Harvesting
You can avoid tax debts by capitalizing on any potential unrealized losses. If you bought assets on the up and now they have tanked to almost nothing, the law allows you to sell losing positions to trigger capital losses. You then use the capital loss to offset capital gains and thus the amount you were likely to pay as tax.
If your capital losses for the year exceed your capital gains, then you are legally permitted to carry over the additional losses that you can use to offset losses in the following year.
You can also claim up to $3,000 in tax rebate on your ordinary income.
3. Be like the banks: Borrowing/Lending
Some crypto traders have found a way to avoid crypto taxes by embracing DeFy platforms that enable crypto loans. This works through borrowing/lending platforms which take cryptocurrency as collateral and give out cash loans.
The idea is that you get to keep your crypto assets while not being required to pay capital gains tax on the cash. If the collateral is held for a year or more, you qualify for the long-term capital gains tax rate, which reduces your tax debt.
4. Be thrifty: Invest in an IRA account
Another option is to invest in cryptocurrency and pay no taxes if you use an individual retirement account (IRA), 401(k) plan or another kind of retirement account.
IRAs can handle cryptocurrency investments, including buying and selling as well as the growth of investments tax-free or allowing them to remain tax-deferred until a withdrawal is made.
If you set up a self-directed IRA, then you can manage your crypto trading activities and save on fees too.
5. Have a big heart: Give crypto to charity
Making cryptocurrency donations is another way of cutting down on the overall tax on your adjusted gross income (AGI). When you donate crypto, its fair market value is used to determine any tax-deductible calculations related to the donation.
Do you need to sell that bitcoin to get cash for a donation to a tax-exempt charity? Nope. Use cryptocurrency instead, and benefit from up to a 50% deduction on your AGI! If your donations exceed deductible amounts, no need to panic, as you can carry these over for up to five years.
The Bottom Line
To conclude, If you want to avoid huge tax debt when you trade cryptocurrency, try to avoid triggering so many taxable events. It should also be mentioned that a lot of exchanges only provide data for the last couple of months such as Huobi, so it is best to save your transaction history every few months.
Finally, if you are still unsure about how crypto taxes work you may want to consult a crypto tax accountant who will not only ensure you are compliant but will probably also be able to reduce your tax liability!
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