4 Tax Planning Strategies For Cryptocurrency

Cryptocurrencies have gained a lot of popularity over the years despite their market volatility. The use of this digital currency has become so popular that a virtual currency question has been added to Form 1040. 

What is cryptocurrency?

In simple terms, cryptocurrency is a form of digital money. Unlike traditional cash, where you have coins and paper money to physically represent your currency, cryptocurrencies only reside digitally within the blockchain. 

Blockchain is the platform for cryptocurrency. It is a decentralized network of ledgers that securely holds all data regarding crypto transactions. Each block holds transaction information that is then mathematically linked and referenced to the block that came before it. Everything is encrypted to ensure security. 

Cryptocurrencies and taxes

Many people who invest in crypto have turned in significant profits. And with these profits come taxes. Crypto is considered “property” when it comes to federal income taxes. Cryptocurrencies, like Bitcoin, are considered by the IRS as capital assets. This means that when you sell your cryptocurrency, the difference between the value you bought it for versus the value it sold for is considered either your capital gain (when it sells for more than you bought it), or capital loss (when the sale value is less than what you paid for upon purchase). And it is this capital gain that gets taxed. 

Capital gains or losses can either be long term or short term. And each one is taxed differently:

  • Short term capital gains or losses happen when you buy or sell your assets within a 365-day period. Short term gains are taxed in the same way that your normal income is taxed. Normal income has seven tax brackets identified by the IRS, and they currently range from 10% to 37%. 
  • Long term capital gains or losses happen when you wait more than 365 days before selling an asset. Long term gains usually have lower tax rates. Currently, there are three tax rates — 0%, 15%, and 20% — and the rate at which you are taxed depends on your income. 

Your crypto activities are taxed when:

  • You exchange your cryptocurrencies for fiat money (USD, Euros, etc.)
  • You use crypto to buy goods and services in real life. 
  • You get paid crypto as salaries, wages, or other forms of income. 
  • You receive crypto via airdrop or hard fork. 
  • You trade one cryptocurrency for another. 

Minimizing crypto taxes

There are various ways to minimize the taxes you pay on your crypto income. Below is a list of strategies to help with tax planning for crypto and reduce how much you pay to the taxman. 

  1. Stick to long term gains

We’ve discussed above how long term gains generally have lower tax rates than short term gains. You need to practice a little more patience in order to hold on to your cryptocurrencies for over a year before selling them. This needs some serious strategizing on your part to mitigate any losses, and self-control in holding on to your assets longer. 

  1. Wait to sell until you are in a low-income year

Remember that you are taxed based on how much income you earned throughout the year. Which means that if you are salaried or earning a steady income plus you earn from your crypto investments and activities within the same year, your tax rates will move up a tax bracket or two. Whereas if you turn your short term gains into long term ones, and sell your assets when you are receiving lower, little, to no other income within the year, your tax rate could be as low as 0%. 

Imagine if you are earning a salary that puts you at the midline bracket for tax, and you add to that the gains you have from trading crypto (assuming you trade within 365 days), those gains plus your salary will push you closer to the 37% income tax bracket. But if you have a low income year: let’s say you got laid off or took a part-time job instead of a full-time one, your yearly income would be significantly less, putting you closer to the high-end tax bracket. So, when you add your long-term gains from crypto, your tax bracket remains at the low end, meaning less tax for you to pay. 

  1. Gift or donate crypto

The IRS has a $15000 per person per year cap on non-taxable gifts. So if you need to lower your taxes, think about gifting some cryptocurrencies to your friends and family. You can also donate to charitable organizations. Donations can be deductible when tax season comes around. That is, if it fits into your long-term plans for your investments. Don’t just gift and donate willy-nilly without first talking it over with your investment planner. You do still need to keep your goals in mind when trying to lower your tax rates. 

  1. Claim your losses

Your losses can offset your taxable gains for the tax year. For example, you gained 5000 dollars from selling one of your assets but also suffered a $5000 loss on another investment, you basically just broke even and do not owe any taxes. If you lost more than you gained in a year, you can get up to a $3000 deductible and then roll the rest of the losses to offset future gains. 

There are a myriad ways to reduce your taxes on crypto gains. You just need to do your research, consult with experts, and keep a meticulous record of your finances throughout the year.