Calculating cryptocurrency taxes and pulling together all the necessary information for tax reporting is never the most exciting thing for bitcoin investors. The whole process can be painful – especially if you have been trading across multiple exchanges.
However, December presents the best time of the year to work on strategically minimizing your crypto tax liability, as the tax year ends once the new year hits. This article discusses some of the best approaches to reduce your tax liability within the world of cryptocurrency.
Harvest Your Bitcoin Losses
It’s no secret that we’ve seen bitcoin lose significant value from the summer of 2019 and into December. Many traders and investors are sitting on significant losses for the year. If you are in this situation, one of the most effective ways to reduce your crypto tax liability is to engage in tax-loss harvesting.
Tax-loss harvesting is the practice of selling a capital asset at a loss to offset a capital gains tax liability. By realizing or “harvesting” a loss, investors are able to offset taxes on both gains and income. This is a tax reduction strategy commonly used in the world of stocks and securities.
For example, if I purchased $10,000 of bitcoin in July, that investment would now only be worth $5,000. Rather than sit on my losses and continue to hold, I could sell or trade this bitcoin for another crypto and realize my $5,000 loss. This loss would reduce my capital gains as well as my taxable income for the year.
This is a simple example of course, but for certain investors who have multiple trades across years and exchanges, they could save a tremendous amount by strategically harvesting their crypto losses. Take these into account when doing your bitcoin tax reporting.
Keep Accurate Records and Leverage Specific Identification Costing Methods
After the new IRS cryptocurrency tax guidance was released in October 2019, the agency clarified that specific identification costing methods like LIFO could be used if you had the appropriate records to specifically identify your crypto assets. This was a big win for crypto investors as specific identification calculation methods can help minimize your capital gains.
To specifically identify a unit of cryptocurrency, you must include the following information:
- The date and time each unit was acquired,
- Your basis and the fair market value of each unit at the time it was acquired,
- The date and time each unit was sold, exchanged, or otherwise disposed of, and
- The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit
If you have this data for your transactions, you are able to use specific identification methods like LIFO or HIFO which can drastically lower your taxes when reporting your cryptocurrency.
Hold Your Crypto Investments For Longer Than One Year
Another great way to reduce your tax liability is to hold your crypto investments for longer than one year. Because crypto like bitcoin is treated as property for tax purposes, the same capital gains and losses rules that apply to other forms of property like stocks, bonds, and real estate also apply to crypto.
When you hold onto your crypto investments for longer than one year, long term capital gains tax rates apply. When you hold for less than one year, you are taxed at the short term capital gains rate, which is typically greater than the long term rate.
So before selling or trading your crypto, you should check to see when you initially acquired the coin to determine if you will qualify for long term capital gains.
Trade Crypto With a 401-K Account
Leveraging a retirement account like a 401-K or IRA is another great way to minimize or defer your crypto taxes. When using a retirement account, you can defer paying tax, all of the income you realize within the 401-K account will be tax-deferred. This is contrary to using a traditional cryptocurrency exchange where the income generated from selling or trading crypto is taxed during that year. Crypto 401-K’s and IRA’s can be a great tax reduction tool, especially if you believe in the long term value of cryptocurrencies.
With the end of the year right around the corner, now is the time to take a look at your crypto portfolio and assess how you can structure it to minimize how much you pay in crypto taxes. Leveraging some of the tips listed above can potentially save you thousands of dollars in taxes depending on your situation.