Bitcoin has come a long way in the past 15 years, from an experimental hobby to a serious and viable investment asset. If you were an early adopter, you saw your investment grow in big ways. That was the easy part. When it comes to cashing out, selling Bitcoin can be a little…complicated.
You’re looking at this great Bitcoin portfolio, but unfortunately, cashing out is not as easy as pressing “sell” and watching the dollars roll in. You have to consider liquidity, regulatory compliance, and taxation. Without a well-thought-out strategy, you’ll lose up to 40% of your earnings to capital gains taxes.
In this blog we will dive into the challenges of selling large Bitcoin holdings, important things to consider when crafting a selling strategy, and how to avoid giving so much of your hard-earned assets to the IRS. Whether you are ready to make a big sale or just testing the waters, we are here to help you make the most of your Bitcoin windfall.
The Challenges of Selling Large Bitcoin Holdings
There are a number of challenges you’ll face when you try to sell large Bitcoin holdings.
Liquidity
The first of these challenges is liquidity constraints. Liquidity refers to how easily you can convert Bitcoin into cash without significantly affecting the market price. If you are selling a large amount of Bitcoin, and you aren’t careful, you can experience slippage and end up with less money than you expected.
Here’s an example. Let’s say you want to sell 20 BTC, which is currently trading at $50,000 per coin. You expect to get $1 million. However, you attempt to sell it all at once using a market order. That means you sell it all at the best available price. There are only so many buyers willing to purchase your BTC at $50,000 a coin. As more of your orders get filled, they sell for lower prices.
In the end, you end up with $992,500 instead of the $1 million you were expecting. That is a loss of $7,500 to slippage. Slippage isn’t a fee; rather, it is the hidden cost of trying to move large amounts of money through a market where there isn’t enough demand. A more liquid market or a carefully managed sale can help you avoid excessive slippage.
One way to deal with the challenge of liquidity is to sell your BTC in tranches or smaller amounts rather than in one big chunk. This insulates you against the volatility of the crypto market as well. Another solution is to use an over-the-counter (OTC) desk for large trades. An OTC matches buyers and sellers without affecting the market price.
Taxes
The tax implications of selling a large amount of Bitcoin can be significant. To avoid surprises or overpaying on taxes, you’ll want to understand exactly what you owe when selling BTC.
The IRS treats Bitcoin as property, not as currency, so you’ll be subject to capital gains taxes when you sell it. Capital gains taxes are calculated based on the difference between your basis (what you bought the Bitcoin for) and the current selling price.
Your profits will also be taxed differently depending on whether the IRS considers them long-term or short-term assets. The IRS taxes long-term assets at a lower capital gains tax rate. Short-term assets are taxed at the higher income tax rate. Long-term assets are anything you have held for over a year.
Accounting Methods
Calculating your capital gains with cryptocurrency can be tricky, particularly if you didn’t buy it all at once. Hiring an accountant or tax professional can help you make the most of your Bitcoin, but here is a quick overview of two different account methods you can use to calculate your capital gains and the impact of each.
FIFO (First-in, first-out)
This is the default accounting method used by the IRS. If you bought Bitcoin multiple times at various prices, the FIFO uses the oldest purchase as the basis. For example, let’s say you bought 1 BTC in Jan 2022 for $10,000, 1 BTC in Jan 2023 for $20,000, and 1 BTC this year for $30,000. You sell 1 BTC today for $50,000.
With the FIFO method, you would use the oldest purchase price as your basis. So your capital gains would be $50,000-$10,000 = $40,000. You have had that BTC for a couple of years, so you would be taxed on the $40,000 at the long-term rate.
LIFO (Last-in, first-out)
With this accounting method, you sell your most recently acquired asset first. So, in this example, you would sell the 1 BTC you bought earlier this year for $30,000. Your capital gain would be $50,000-$30,000 = $20,000. You would realize a smaller capital gain, which can reduce your taxes. However, in this example, you have only held the asset for a few months, so you would have to pay the higher short-term tax rate.
Specific Identification
You pick exactly which asset you are selling. So, you’d say, “I am selling the 1 BTC that I bought for $20,000 on this specific date.” This is the most flexible accounting approach, giving you the most control over your capital gains taxes. But it requires detailed bookkeeping or dedicated cryptocurrency tracking software.
Regulatory Compliance
When selling cryptocurrency, especially large holdings, you must be aware of some rules to follow so you don’t trigger an investigation from the IRS, the SEC, or other regulatory agencies.
Know Your Customer (KYC) is a set of identity verification processes financial institutions use to prevent fraud and theft. The identification the institutions (including crypto exchanges) collect usually includes your full name, a government-issued ID, proof of address, and sometimes a selfie or video verification.
Anti-Money Laundering (AML) is a set of procedures that bank institutions and regulating agencies use to identify and flag suspicious behavior. It prevents illegally gained money from being “cleaned” by passing it through the financial system. KYC is a first step; transactions are monitored, and suspicious transactions are flagged. So, if you suddenly send a large amount of BTC to an exchange like Coinbase and convert it to cash, it will trigger extra scrutiny.
Best Methods for Selling Large Bitcoin Holdings
So, with all of the challenges involved in selling large Bitcoin transactions, what is the best way to convert your highly appreciated BTC assets to cash?
Over the Counter (OTC) Trading
You want to use OTC trading when you want to move a large amount of BTC (over $100K or more) without moving the market. An OTC is an exchange arranged with a single buyer. It allows you to avoid slippage, and you avoid rate limits.
Some OTC desks offer concierge services, providing tailored support, escrow, and help with regulatory compliance. You will still have to follow KYC/AML rules when using an OTC desk, which might be a drawback if privacy is a main concern. If you aren’t using a trusted OTC desk, you risk negotiating with shady buyers.
Structured Selling
Structured selling strategies remove some of the emotional decision-making and allow you to mitigate some of the risks of a volatile market.
Dollar Cost Averaging Out (DCA) is a strategy where you sell a fixed amount of BTC at regular, pre-scheduled intervals. In this way, you avoid slippage and manage some of the risks of an unpredictable market. On the downside, you might miss out on some big profits if the market surges.
Another way to avoid slippage is to use Limit orders on exchanges. This means that you sell on your desired platform but place limit orders at your desired price. The BTC will only sell at that price or above. You control the price, and you can layer your orders to sell at gradually rising prices. However, if the price doesn’t reach your desired level, your orders may not fill.
Peer-to-Peer (P2P) Sales
A direct or peer-to-peer sale is when you forgo a formal exchange or OTC desk and instead sell directly to a friend, OTC peer, or someone you find on a P2P platform like Paxful or Bisq. A P2P sale allows you to avoid slippage and exchange fees and offers more privacy.
However, there are some real drawbacks. You have to be extra careful that you don’t get into legal trouble and that you follow all the local tax and AML laws. P2P sales are particularly vulnerable to scammers, and finding a buyer willing to purchase large holdings can be difficult.
Tax Planning Strategies for Bitcoin Sales
While we all want to know how to sell Bitcoin without paying taxes, the truth is that avoiding taxes altogether is unavoidable. However, there are steps you can take to drastically reduce the capital gains taxes you pay and maximize the return on your BTC investment.
Deferred Sales Trusts
A Deferred Sales Trust (DST) is a flexible and effective way to defer capital gains taxes when selling any asset, including Bitcoin. By deferring the realization of your capital gains taxes, you can spread your tax burden out over time or even reduce your overall taxes by keeping yourself in a lower tax bracket. If you choose to reinvest all of your proceeds and take interest-only installment payments, you can keep 100% of the capital gains tax remaining deferred.
A Deferred Sales Trust works by utilizing an installment sale. Instead of selling directly to a buyer through an OTC desk or crypto exchange, you sell your BTC to an independent, third-party trust—a Deferred Sales Trust. In exchange, you’ll receive a promissory note outlining the terms of your repayment. The DST will then sell your BTC and take receipt of the proceeds.
Because you don’t have direct control over your profits, you don’t owe any capital gains taxes. The Deferred Sales Trust trustee will then reinvest your proceeds based on your desires and risk tolerance. You can choose to take interest-only payments or receive regular installments of your profits. You only owe taxes on the portion of your proceeds that you receive in installments each year.
This allows you to reinvest all of your profits before losing 20-30% to capital gains taxes. Using a DST allows you to maximize your returns and earn as much money as possible.
Charitable Contributions
Even if using a DST, you will still owe capital gains taxes on the portion of your profits that you receive in installments each year. One way to reduce the taxes you owe is through charitable contributions. If you donate BTC directly to a charitable organization, you won’t owe any capital gains taxes on the appreciation, and you can deduct the full fair market value of the donation from your taxes. That’s a double benefit—no taxes on your appreciated asset and a deduction on your taxes.
Harvest Losses
If you are selling highly appreciated Bitcoin, it might also be a good time to sell some of your underperforming assets as well. You offset capital gains with capital losses in the same year.
For example, you want to sell a highly appreciated BTC for a $50,000 profit. You have ETH that hasn’t been performing well. If you sell your ETH at a loss of $50,000, it will offset the gain from the BTC, and you won’t owe any taxes.
Developing Your Strategy
Cashing out a large Bitcoin holding is more complicated than selling a traditional asset. However, with the right information and careful tax planning, a strategy that will minimize your taxes and maximize your returns is possible.
If you plan on selling a large Bitcoin holding, consider working with a capital gains tax advisor and a financial professional. They will help you choose the right cash-out strategy, ensure you comply with all legal requirements, and don’t overpay on taxes. With the right capital gains tax strategy, you can maximize your profits and continue earning passive income for years.
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Infographic
Although you can’t completely avoid taxes when selling Bitcoin, several effective strategies can help minimize your capital gains liability and retain more of your investment returns. Read on to learn more in this infographic.
