Capital Gains Tax Deferral On Digital Assets
If you were smart enough to invest in cryptocurrency early on, you might be looking at some large gains. You might also be wondering how to sell your crypto without paying taxes. The short answer is that you can’t avoid crypto taxes completely, but there are ways of reducing or delaying them.
U.S. investors are required to both report and pay taxes on cryptocurrency investments, airdrops, and income earned from staking or mining. This page will help you understand your crypto tax obligations and methods for reducing or deferring your cryptocurrency taxes.
Can the IRS Track Earnings from Cryptocurrency?
The IRS has made significant efforts in the last few years to improve its ability to track cryptocurrency earnings. So, if you are wondering if airdrops are traceable or if you can get away with not reporting your crypto investments, you might want to think again.
- All the major virtual currency exchanges are required to complete KYC (know your customer) checks, meaning they must carry out certain background checks to verify their customers before allowing them to use their platform.
- Crypto exchanges provide customer information, including wallet addresses, to the IRS.
- Blockchain technology allows for the traceability of cryptocurrency transactions. Even though you might feel like your transactions are anonymous, they aren’t.
- The IRS employs blockchain and crypto specialists to link wallets to individuals.
- The IRS has won legal cases against Kraken, Coinbase, and Poloniex, forcing them to share their customer data with the IRS.
- The IRS recently introduced a new checkbox on Form 1040 asking if you received, sold, exchanged, or disposed of a digital asset in the last year.
Short-Term vs. Long-Term Crypto Tax Rates
Short-Term Capital Gains
If you buy Bitcoin and then sell or trade it within the same year, it is treated as income and is taxed at the appropriate income tax rate. The federal government taxes income at rates as low as 10% and up to 37% for the highest earners.
Long-Term Capital Gains
Because the federal government wants to incentivize long-term investments, they tax assets held for over a year at a lower rate. If you bought Ether and sold it for a profit after three years, it would be taxed at the long-term capital gains rate, which varies between 0% and 20%, depending on your income tax bracket.
Other Crypto Tax Considerations
Staking or Mining Rewards
Awards for actions such as staking or mining are treated as income and are taxed accordingly.
Airdrops
The IRS clearly states that airdrops are a form of income and should be reported accordingly. To determine the amount of income you received, use the fair market value of the coin or token on the day you received it.
Trading for Another Asset
If you want to trade your USDT for XRP, you must report that on your taxes. If you use your Cardano to buy goods or services, that is another action you must report to the IRS when you file taxes. If you are given Dogecoin in exchange for goods or services you provide, that will need to be reported as income.
Transferring to Another Wallet
If you transfer your Bitcoin assets to another wallet, the IRS does not consider this selling, and it does not need to be reported or taxed.
How Is Crypto Taxed?
The IRS determined long ago that cryptocurrencies should be treated as property, or an asset, for tax purposes. Failure to accurately report cryptocurrency earnings could lead to fines or even prosecution. The rate at which the IRS taxes your crypto earnings depends on a few factors.
How Long You’ve Held the Asset
Like all capital gains, the IRS taxes long-term crypto assets at a lower rate than short-term assets. The IRS defines long-term assets as those held for over a year.
Your Income Tax Bracket
Short- and long-term capital gains are taxed at different rates depending on your income tax bracket. This is why deferring or delaying the realization of your capital gains can sometimes be a useful tool. If you can defer until a year when your taxable income is lower, you can potentially reduce your tax burden.
The State You Live In
Most, but not all, U.S. states levy their own capital gains taxes. However, the rate varies significantly from state to state. Only eight states do not tax capital gains (including gains from crypto assets):
- Alaska
- Florida
- New Hampshire
- Nevada
- South Dakota
- Tennessee
- Texas
- Wyoming
Reducing or Delaying Capital Gains Taxes on Cryptocurrency
We are frequently approached by investors who want to know how to avoid capital gains taxes on their cryptocurrency. These are our recommended methods for reducing, offsetting, or deferring capital gains taxes on crypto.
Hang on to Your Assets
The easiest way to reduce your tax liability is to hold onto your crypto assets for at least a year so that you pay the lower long-term capital gains rate.
Donate in Crypto
If you are making regular charitable donations, consider donating crypto directly. Not only will you feel good about yourself, but your donations won’t be taxed, and you get the double benefit of deducting your donations, reducing your overall tax burden.
Sell for a Loss
Many savvy investors will sell assets that have lost value to offset gains in other areas. This is called harvesting losses. If you sell any asset at a loss (stocks, bonds, cryptocurrency), you can leverage those capital losses to offset capital gains. If your losses exceed your gains, you can roll over the losses to offset gains in future years.
Use a Deferred Sales Trust
A Deferred Sales Trust (DST) is a method for capital gains tax deferral on cryptocurrency. It is a form of an installment sale in which you sell your crypto assets to an independent trust. The trust will dispose of your assets on your behalf, then reinvest your proceeds and repay you over time in installments. This allows you to reinvest in other assets (crypto or otherwise) without paying capital gains taxes. Your capital gains taxes will be deferred until you receive the proceeds from the trust, giving you flexibility in timing and investment options.
How Does a Deferred Sales Trust Work?
Let’s say you bought ETH at a cost basis of $100,000. It is now worth $2 million. If you were to sell it right now, you would owe taxes on a capital gain of $1.9 million. In a state like California, even at the long-term rate, you could owe upwards of $627,000 in capital gains taxes. That means you would only have $1.4 million to reinvest.
However, if you use a DST, you would transfer your ETH to the third-party trust, which would simultaneously dispose of it and take possession of your proceeds. You don’t owe any taxes because you have not yet received any profit. The trust can then invest all $2 million on your behalf.
You decide the terms of the trust–you can choose to reinvest all of your proceeds and be paid only the interest earned. Or, if you want more liquidity, you can invest some of your profit and receive the rest in installments. You will only owe taxes on the proceeds that you receive. You have complete flexibility in timing, investment options, and liquidity.
Why You Need Professional Help
Crypto taxes can be surprisingly complicated. The basic formula for calculating capital gains is simple: subtract the cost basis (the fair market value when you bought the crypto) from the proceeds (what you sold it for). In practice, it can be much more confusing, which is why you would benefit from the help of a team of experts. Here are some reasons crypto taxes can be confusing:
- You’ve bought and sold multiple times – Most high-net-worth investors haven’t just bought and sold once. You might have bought SOL at a rate of $100, then again when it was $500, and again when it was $1,000. If you later sell a fraction of your shares, which cost basis do you use?
- You’ve used multiple exchanges – Many different cryptocurrencies and exchanges exist. If you have bought and sold using Kraken, Coinbase, Binance, and Robinhood, it can be hard to track all your transactions and awards.
- Crypto awards are taxed differently – If you have received an airdrop reward or earned money by staking or mining, those earnings are taxed as income on a different cost basis.
- You’ve traded cryptocurrencies – If you have used SOL to buy Dogecoin, you are not just swapping currencies. The IRS treats this the same as selling one currency and buying another, and you are taxed on the exchange.
Why Choose Capital Gains Tax Solutions?
Not only can the professionals at Capital Gains Tax Solutions help you navigate the complexities of crypto taxes, but they also have years of experience setting up Deferred Sales Trusts to achieve capital gains tax deferral on cryptocurrency. They are uniquely equipped to evaluate and calculate your current tax liability and set up a DST to meet your needs and help you achieve your financial goals.
Professional Service
When you use Capital Gains Tax Solutions, you have access to our team of tax attorneys, CPAs, Deferred Sales Trust trustees, and financial advisors.
All of them work together to really dig into your unique financial needs and challenges and find the solution that not only meets your needs but will transform your wealth.
Unparalleled Experience
Our team at Capital Gains Tax Solutions has a combined 14 years of experience building Deferred Sales Trusts for clients in a variety of industries and financial markets. We know the investment industry in-depth and are committed to ensuring you understand it, too.
We think that the Deferred Sales Trust is a versatile and reliable investment tool, but we won’t move forward until we have helped you explore all your options and you feel comfortable and confident in your decision. We are experts on capital gains tax deferral on cryptocurrency as well as real estate, stocks, and businesses.
Tested
Many of our clients haven’t heard of the Deferred Sales Trust and are skeptical that it is legal and ethical. Let us reassure you. We have successfully closed 14 IRS audits and eight state audits of the DST with no changes.
The Deferred Sales Trust has been tested in nearly every financial market for the last 30 years. To be sure you feel confident, we offer lifetime audit defense at no additional charge.
Trustworthy Leaders
Our founder and DST trustee, Brett Swarts, is a long-time tax deferral expert, real estate investment professional, author, podcast host, and Deferred Sales Trust expert.
He is a devoted husband and father of five. You can ask any of our thousands of clients; we are confident they would recommend Brett for his no-nonsense approach to providing clarity and options for clients looking to exit highly appreciated assets.
Three Easy Steps
Consultation Phone Call
Clarify and Explore
If you want to move forward with a Deferred Sales Trust, we will meet again to really dive into your assets, your financial goals, and your risk tolerance. Our tax attorneys will then build the structure of a DST to meet your needs. If you can give us just five hours of your time, we will ensure that you feel knowledgeable and confident in how the Deferred Sales Trust can work for you.
Implement
Don’t Delay
Don’t wait to reach out for your consultation. Even if you don’t intend to exit right away, cryptocurrency prices can fluctuate rapidly. Timing is everything.
Act now to set up a Deferred Sales Trust so that you are ready to move when the time is right. With our help, you can achieve freedom and flexibility and feel confident about your crypto exit plan.
