Nothing in life is certain but death and taxes, right? This might be true, but the amount of money you pay in taxes is anything but certain. Cryptocurrency has the potential for incredible returns, and you want to make sure you keep as much of it as possible. While you can’t completely avoid paying taxes on your cryptocurrency, you can ensure that you minimize your tax obligations and maximize your increase on your investment.
What Affects Your Crypto Tax Rate?
Your cryptocurrency is taxed differently based on whether it is assessed as income or capital gains. All your earnings from crypto staking, mining, or payments are taxed as income at whatever income bracket you fit into.
Cryptocurrency is taxed as capital gains anytime you dispose of it–whether through selling, trading for another cryptocurrency, or using crypto to pay for goods and services. If you dispose of your cryptocurrency within one year of purchasing it, you will owe short-term capital gains taxes, which can vary based on your income tax bracket. Long-term investments are taxed at a lower rate. Thus, holding your investment longer reduces your tax liability out the gate.
How to Maximize Your Crypto Returns
1. HODL
“HODL” is a phrase that originated in a misspelled post on a Bitcoin forum in 2013, where an investor said they were “hodling” their Bitcoin despite the ups and downs of the market. It has since come to represent the strategy of holding crypto assets through short-term market fluctuations.
Holding onto your investments is one of the smartest ways to reduce your tax liability and maximize your returns. The United States encourages long-term investing by taxing investments held for over a year at a lower tax rate. As long as you wait 12 months or more to dispose of your crypto, your tax rate will be significantly lower. The short-term capital gains tax rate is 10-37%, while the long-term tax rate is 0-20%. So, while you might not be able to sell your crypto without paying taxes, you can certainly hold your investment long enough to qualify for a lower tax rate.
2. Harvest Your Losses
Harvesting an unrealized loss means that you sell, swap, or trade your currency at a loss. For example, if you bought $30,000 worth of BIT, but it is now only worth $24,000, that is an unrealized loss. If you sell it for $24,000, that is a realized loss, and it can have significant tax benefits.
When you realize your losses on your crypto investment, they can offset your capital gains for the year or up to $3,000 worth of income. If your net losses exceed your capital gains, you can roll them into the following year.
Strategically selling investments at a loss has been a well-known strategy for decades, but there is an additional benefit to doing so with cryptocurrency. Most tax experts agree that the wash sale rule does not apply to crypto. This means that, unlike other assets, you can still claim a loss on crypto even if you buy it back within 30 days.
3. Offset Capital Gains with Losses
Another way to sell crypto without paying taxes is to leverage unrealized losses in your other investments. Let’s say you made $20,000 selling Bitcoin; you could sell a traditional investment at a $20,000 loss, and you would not owe any taxes on your crypto earnings. So, if you are about to realize significant gains on the sale of cryptocurrency, now is a good time to identify losing investments in your portfolio. It might be the perfect time to sell and offset your crypto gains.
4. Invest Using an IRA
An IRA is a savings account specifically designed to help investors save for retirement while minimizing their tax burden. With a traditional IRA, your contributions are tax-deductible, and you don’t pay taxes on your capital gains until you withdraw your funds at retirement. Contributions to a Roth IRA are not tax-deductible, but you don’t pay any taxes when you withdraw funds in the future, even if those investments have increased in value.
Not every IRA allows cryptocurrency, but using one of the self-directed IRAs that accommodate crypto can be a smart move and can help you significantly reduce your tax burden. Investors under 50 can contribute up to $7,000 to all their IRAs in 2024.
5. Realize Gains in a Low-Income Year
The taxes you owe on your crypto is determined by your income bracket. Some investors choose to realize their cryptocurrency capital gains in a year when their income is lower–such as when they are students or are in between jobs. Timing the sale right ensures they will be in a lower tax bracket and will pay fewer taxes on their gains.
6. Gift and Donate Crypto
If you want to avoid capital gains taxes on cryptocurrency, one of the best things you can do is gift or donate your crypto. If you give cryptocurrency, you have no tax obligation on that gift up to $17,000. Receivers of cryptocurrency also do not have to pay taxes on the gift.
Donating cryptocurrency has double benefits–the donation is not taxed, and if you donate to a registered charity, your donation is tax-deductible. Just make sure you check the charity’s 501c(3) status with the IRS’s exempt organization database.
7. Take Out a Crypto Loan
If you need to cash out some crypto quickly, it may come with a large tax bill. One way to leverage crypto without paying taxes is to put your cryptocurrency up for collateral on a crypto loan. Taking out a loan is a non-taxable event, meaning you will get access to currency without having to foot a large tax bill. However, you will want to calculate the interest rates for your repayment to make sure that it is worth it for your personal circumstances.
8. Defer Your Taxes with a Deferred Sales Trust
A Deferred Sales Trust is a legal tool used to defer capital gains tax when you are selling highly appreciated assets like cryptocurrency. With a Deferred Sales Trust, you don’t sell your crypto directly to the buyer. Instead, the trust acts as a third party–you sell your asset to the trust, and the trust sells the asset to the buyer. Instead of getting your payout all at once, you can choose to reinvest it or take portions of your proceeds on a regular basis. While it does not allow you to avoid paying taxes on your crypto assets, you can use this tool to defer taxes and potentially gain more in interest.
Managing Your Capital Gains Taxes on Crypto
There is no way to altogether avoid paying taxes on your cryptocurrency; trying would be dangerous and could be costly. The IRS has the tools and resources to pursue individuals who don’t report their crypto activity. However, managing your finances to reduce your tax bill is entirely legal and can save you thousands of dollars.
Capital Gains Tax Solutions is dedicated to helping investors navigate the complexities of tax filings so that they can realize the greatest gains from their investments. Reach out for a free consultation today to see how we can help you get the most out of your cryptocurrency.