Reduce your Tax Bill in 2023
How to avoid tax on crypto is a tricky area to navigate, especially with the ever-changing crypto regulations and laws. Many investors are unsure how to properly record their gains and losses on their taxes and may face a hefty bill as a result. Crypto investors should understand the tax implications of their investments as well as how to reduce their tax liability. In this guide, we’ll provide an overview of how cryptocurrency taxes work, tax avoidance strategies and 12 easy ways to reduce your crypto tax bill.
Firstly, What are Crypto Taxes?
Cryptocurrency is listed as “property” under federal income tax law. And, for the average investor, the IRS considers it a capital asset. Because of this, taxes on cryptocurrencies are the same as taxes on any other profit achieved from the sale or exchange of a capital asset.
How Do Cryptocurrencies Tax Work?
Before we get into tax-cutting strategies, let’s go over the basics of how cryptocurrency is taxed.
The IRS considers cryptocurrency to be a type of property, similar to stocks and real estate. It is therefore subject to both income tax and capital gains tax.
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If you sell your cryptos, you will have to pay capital gains tax. A few examples of disposal events are exchanging your cryptocurrency for fiat, trading it for another cryptocurrency, and making purchases with it. You’ll have to pay capital gains based on how much your tokens have increased in value since you first received them.
Ordinary Income Tax
If you earn money from cryptocurrency, you must pay ordinary income tax. Income events include getting rewards for staking or mining, getting referral bonuses from cryptocurrency apps, or getting paid for your work in cryptos.
When you buy a stock, bond, house, widget, Litecoin, Bitcoin, or other capital assets, you set a basis equal to its cost. When determining whether you have a capital loss or capital gain, you try comparing the sales proceeds to the basis. Capital gains occur when proceeds exceed the basis. You have a capital loss if you reverse it.
You’ll also need to consider how long you held the asset. Short-term or long-term gains or losses depend on how long you hold your crypto. That distinction will also affect your crypto taxes.
Short-Term Capital Gains and Losses
A short-term capital gain or loss is recognised when you buy and sell an asset within 365 days. Short-term gains are taxed at the same rates as ordinary income, which includes salaries, wages, commissions, and other earned income. In 2022, the IRS has seven tax brackets for ordinary income ranging from 10% to 37%.
Long-Term Capital Gains and Losses
If you buy an asset and then sell it a year later, the difference between the sales price and your basis is your long-term capital gain or loss. Because the rates are generally lower, you’ll pay less tax on a long-term gain than on a short-term gain. Long-term capital gains are currently taxed at three different rates: 0%, 15%, and 20%. The rate you pay is determined by your income.
12 Easy Ways to Reduce your Crypto Tax Bill
How to avoid tax on crypto? Unfortunately, crypto-tax cannot be completely avoided. Remember that taxes must be paid in full. Nonetheless, some legal tax-cutting measures are available. The following are 12 effective methods for lowering taxable income.
1. Take the Benefits of Holding Crypto Long-term
The simplest way to reduce your tax burden is to keep your assets until they are long-term property. You may be eligible for a lower capital gains tax rate if you hold crypto for more than a year. Remember that if you’ve held your cryptocurrency for more than a year, you’ll pay fewer capital gains tax.
Of course, keep in mind that cryptocurrencies are highly volatile. If you anticipate a price drop in the coming months, it may be better to sell now rather than later. Nonetheless, the preferred long-term capital gains rate should be considered when making trading decisions.
2. Apply for a Crypto Loan
Interested in cashing out some of your cryptocurrency profits? Instead, consider getting a loan with your cryptocurrency as collateral.
Getting a loan is not a taxable event, unlike when you sell your cryptocurrency (though the IRS has yet to provide DeFi loan guidance). Getting a loan could help you save money, depending on the interest rate and how much you earn.
3. Utilize Tax-Loss Harvesting
Tax-loss harvesting is a way to save money on taxes by selling investments at a loss to claim tax savings and using the money to buy more investments. This strategy lets you reduce your tax bill by offsetting capital gains with losses.
If the value of some of your cryptocurrency holdings has decreased, tax-loss harvesting may be a useful strategy for lowering your overall tax liability.
Cryptocurrency has a tax-loss harvesting advantage over other asset classes. The “wash sale rule” prevents investors from claiming capital losses if they buy the same stock 30 days before or after selling. The “wash sale rule” does not apply to cryptocurrency. Investors can sell Bitcoin, claim the capital loss, and buy it back.
4. Use a Crypto Tax Software
Cracking your gains and losses manually is difficult because you need to identify the US dollar amount for each trade you made during the entire year.
This makes it more difficult to spot opportunities to harvest tax losses and difficult to file your taxes at the end of the year. Fortunately, there is a workable solution.
Making your tax return filing stress-free is possible with cryptocurrency tax software like CoinLedger. Capital gains can be calculated quickly. Instead, automatically integrate Coinbase, Kraken, and Gemini transactions in minutes.
5. Hire a Crypto Certified Public Accountant (CPA)
It can be difficult to navigate the tax code on your own. That is why you should think about involving the assistance of a professional.
Hiring a skilled accountant may be costly, but many investors find it worthwhile. A cryptocurrency-savvy accountant will be able to cover their fees by identifying tax-reduction strategies.
6. Take Advantage of Crypto Tax-Free Countries
Cryptocurrency gains are not taxed in some countries, including Singapore and Switzerland. Some investors move to areas with lower tax rates, though it may seem extreme.
Currently, there are no income taxes in Wyoming, Alaska, Florida, Nevada, South Dakota, Texas, and other states. Some investors go so far as to relocate to different countries. Portugal currently does not tax crypto sales income. El Salvador has also declared that no taxes will be paid on any Bitcoin profits.
Read more about the best countries for crypto taxes.
7. Use a Self-Directed Individual Retirement Account
Another way to reduce your crypto tax bill is to invest in a tax-deferred or tax-free Self-Directed Individual Retirement Account. So, you can either pay taxes later, when you might have less taxable income in retirement or now when you put money into your Roth SDIRA because you expect to pay more taxes in retirement.
8. Buy & Sell Crypto Via Your IRA
Retirement accounts are intended to help investors accrue wealth tax-free. However, your savings won’t be accessible until a certain age. Traditional retirement accounts receive tax-free income, but all gains and potential withdrawals are subject to taxation.
Traditional retirement accounts receive tax-free income, but all gains and potential withdrawals are subject to taxation. Roth retirement accounts, on the other hand, are funded with taxable income, but all profits and withdrawals are tax-free. For instance, if you sell your capital assets in a Roth IRA, you won’t have to pay capital gains tax until you take out your money.
Unfortunately, a lot of popular IRA providers do not allow customers to make direct crypto investments. Fortunately, there are other options.
Self-directed IRAs allow investors to put their retirement savings in different assets like real estate, precious metals, and digital currencies. If you’re under 50, you can contribute $6,000 to all your IRAs, including self-directed ones.
9. Give Cryptocurrency as Gifts
Crypto gifts have their own set of tax advantages. You have no income tax obligation if you give virtual currency as a gift. This form is mostly for informational purposes, but gifts over $15,000 require you to submit a gift tax return.
This may appear to be a difficult step. Giving a crypto gift, on the other hand, could be a great way to share your wealth with family and friends.
The recipients also gain tax advantages. Receiving a cryptocurrency gift is not a taxable event.
However, the gift recipient must track the crypto’s price at the time they received it. These amounts are used to calculate the recipient’s gain or loss when the cryptocurrency is sold.
10. Offset Capital Gains with Capital Losses
Offsetting capital gains with capital losses is another way crypto investors can reduce their taxes. This works by deducting taxable gains on cryptos or other investments that have increased in value from losses on cryptos sold during the year.
However, this strategy has limitations. When recognising investment losses, you must first offset similar losses. For instance, long-term losses reduce your long-term gains while short-term losses first lower your short-term gains.
After that, you can offset capital gains with net losses. For instance, you can offset any remaining long-term capital gain with excess short-term losses.
You can use any remaining net capital loss to reduce your ordinary income. However, you can only use up to $3,000 in capital loss to reduce your ordinary income in any given year if you pursue this strategy. The remaining balance is carried over to offset future gains or reduce your ordinary income by up to $3,000.
11. Take Profits in a Low-Income Year
Remember that the tax rate you pay on cryptocurrency sales is determined by your income bracket in any given year. Thus, some investors profit from cryptocurrency gains in low-income years.
In some cases, this can have a significant impact on your tax bill. Selling during a low-income year can reduce taxes on both short-term and long-term gains. Short-term gains, which are taxed as ordinary income, will prevent you from accruing as much additional income that would otherwise put you in a higher tax bracket.
12. Give a Crypto Donation
Donating crypto can be an excellent way to contribute to worthwhile causes. Furthermore, donating cryptocurrency is a rare instance in which the IRS allows crypto investors to ‘double dip’ on tax advantages. Donating cryptocurrency is one of the few times when it is not taxed.
In addition, cryptos donated after a year of ownership can be deducted based on their fair market value at the time of donation.
Do you legally have to pay taxes on crypto?
It is necessary to pay cryptocurrency taxes. Under federal law, cryptocurrency transactions are taxable as property transactions. Those who use crypto may be subject to taxation if the value of their assets rises.
Is cryptocurrency subject to capital gains tax?
Yes, cryptocurrency is considered property in most countries and is subject to capital gains tax.
How much tax do I owe on crypto?
Your crypto tax liability varies based on how much you spend or exchange, your income and tax bracket, and how long you held the crypto. For instance, if you’ve owned it for less than a year, you’ll pay income taxes, and if longer, capital gains taxes.
Do I pay taxes on crypto if I don’t sell??
Taxes are only due on cryptocurrency when a gain is achieved, which can only happen when you sell, use, or exchange it. The possession of crypto is not a taxable event.
How to avoid tax on crypto investments?
The only way to legally avoid paying taxes on your cryptocurrency is to not use it. If your cryptocurrency increased in value, you’ll have to pay taxes when you sell it, use it, convert it to fiat, exchange it, or trade it.
However, you can lower your tax bill by using these tips. Hold until your short-term gains turn into long-term gains, sell in a low-income year, lower your taxable income, invest in crypto in a self-directed IRA, give the assets as gifts, and do many other things.
Cryptocurrency investors may find taxation confusing. This article discussed the means to lower your tax bill. Now you know how to avoid tax on crypto. Understanding your investments’ tax implications and using tax software, tax-loss harvesting, and tax-free exchanges can also lower your crypto tax bill.