While crypto investments have the potential to bring in profits, they also come with complex tax implications. As such, it is important for crypto investors to understand crypto tax strategies to minimize their tax liabilities while maximizing their profits.
In this article, we’ll cover the benefits of following a sound crypto tax strategy and the top 5 ways to boost profits and slash taxes. We also explain how crypto tax software such as Accointing can help you reduce your crypto taxes.
Definition of Crypto Tax Strategy
A crypto tax strategy refers to a set of techniques that individual investors or businesses can use to reduce their tax liability on crypto investments. A well-executed crypto tax strategy can bring you from paying a substantial tax bill to a significant reduction in taxes owed. Investors who prioritize understanding and implementing effective tax strategies are better positioned to maximize their profits and achieve their financial goals in an expanding crypto market.
How is Crypto Taxed?
Two types of taxes apply to cryptocurrencies in the US tax code: income tax and capital gains tax. Income tax applies if you receive crypto as income. On the other hand, capital gains tax applies when you sell or trade any crypto asset for more than the original purchase price, resulting in a profit.
If you sell a crypto asset at a loss, you can use that loss to offset other gains in the same tax year. If your losses exceed your annual gains, you can deduct up to $3,000 of the excess loss from your ordinary income. Any remaining excess loss can be carried forward to future tax years.
Any time you receive crypto as income, it is subject to income tax and you should report it on your income tax return. The list of taxable crypto events includes (but is not limited to) mining income, staking income, staking rewards, master node income, nodes, hard forks, airdrops, liquidity pool income, interest & yield, rewards, trade or business crypto income, and receiving crypto as compensation.
If you open your wallet (or exchange account) and you have more coins or tokens there than you had before, then the new coins or tokens received should be recognized as ordinary income based on their value at the time you obtained control of the coins.
Capital Gains Tax
The Internal Revenue Service (IRS) treats cryptocurrency as property for tax purposes, which means that selling, trading, or exchanging crypto for fiat currency or other cryptocurrencies triggers capital gains tax. CGT is the tax that applies on the profit made from selling or trading an asset that has increased in value since it was acquired. For example, if you bought Bitcoin for $5,000 and then sold it for $10,000, the $5,000 you made in profits would be subject to capital gains tax.
When calculating capital gains tax, it’s important to determine your cost basis or the amount of money you paid to acquire the asset. The cost basis includes the crypto asset purchase price, any transaction fees, and any other expenses related to making the purchase.
There are two types of capital gains tax: short-term capital gains tax and long-term capital gains tax. Check out the sections below for a deep-dive into the differences between short-term and long-term gains and how they affect your tax liability.
Benefits of a Crypto Tax Strategy
Crypto assets have become a popular investment choice for many investors outside the crypto space due to their potential for high returns. However, it’s important to remember that with investing comes tax obligations. This is where a crypto tax strategy comes into play.
Following a crypto tax strategy means that you have a plan to minimize the tax impact of your crypto investments. By implementing a tax strategy, investors can take advantage of tax breaks and minimize the amount of tax they owe. Here are some of the benefits of having a sound crypto tax strategy:
- Reduce tax liability: A crypto tax strategy can help investors reduce their tax liability by taking advantage of tax deductions, credits, and other incentives. Investors can minimize the tax they owe by planning ahead and making strategic investment decisions.
- Avoid penalties: Failing to properly report crypto transactions can result in penalties and fines from the IRS. A crypto tax strategy can help investors avoid these penalties by ensuring that all transactions are accurately reported, and all tax obligations are met.
- Improve investment decisions: By considering tax implications when making investment decisions, investors can make more informed choices about their investments. This can lead to better returns and improved overall investment performance.
- Simplify tax preparation: Crypto investments can be complex and require detailed record-keeping. A tax strategy can help simplify tax preparation by ensuring that all necessary information is available and organized.
- Increase financial stability: By managing tax obligations and minimizing tax liability, investors can increase their financial stability and reduce the risk of financial difficulties in the future.
By developing a strategy that considers their individual needs and circumstances, investors can enjoy the many benefits of crypto while ensuring they stay on the right side of the law.
Determining Your Tax Liability
Determining your tax liability accurately can be complicated when it comes to crypto asset taxes. However, this is essential if you want to ensure compliance with tax laws and avoid penalties. The key factors to consider when determining the tax liability of your crypto transactions include:
Calculating Your Cost Basis for Crypto Transactions
This refers to the method used to determine the value of your crypto holdings and how much tax you owe on them. The cost basis is the original price paid in USD or another fiat currency for the crypto asset plus any fees or commissions paid during the transaction.
To calculate your cost basis manually, you must keep track of every transaction made for each crypto asset you own, including purchases, sales, and swaps. This can quickly become exhausting, especially if you’re a trader or have many transactions on your crypto portfolio. Calculating your cost basis involves accounting for every buy and sell order, fees, slippage, and even crypto received from mining, airdrops, and forks.
Most crypto investors today use crypto tax and portfolio tracking software to help them Accointing, you can automate the tracking of your crypto assets and calculate your cost basis efficiently, saving you the tedious task of manually entering every transaction. Learn how Accointing can help your tax reporting.
Keeping Track of Crypto Transactions for Tax Purposes
Keeping track of crypto transactions is essential in managing your crypto taxes. With the IRS cracking down on crypto tax compliance, it’s important to ensure that you accurately track your crypto transactions for tax purposes. One of the easiest ways to do this is using crypto tax software like Accointing. Our platform enables you to import your exchange and wallet data, live-track your crypto transactions, and keep records of all your trades.
By keeping track of your crypto transactions, you will not only accurately calculate your cost basis, which, as previously mentioned, is essential for determining your tax liability. Additionally, it helps you avoid costly mistakes and ensures that you’re fully compliant with IRS regulations.
Understanding Long-term and Short-term Gains on Crypto Assets
The classification of your gains will determine how much you owe in taxes and the rate at which you are taxed. Therefore, understanding the difference between long-term and short-term gains on crypto assets is important.
Short-term gains are profits that are made on assets that are held for less than one year. These gains are taxed at the ordinary income tax rate, which ranges from 10% to 37%, depending on your income level. So, if you buy Bitcoin in January and sell it in May for a profit, the profit will be subject to your ordinary income tax rate.
Conversely, long-term gains are profits on assets held for over a year. These gains are taxed at a lower rate than short-term gains and are subject to capital gains tax. Your income level determines the capital gains tax rate, which ranges from 0% to 20%. So, if you buy Bitcoin in January and hold it until December of the following year, any profit made on the sale will be subject to the capital gains tax rate. Holding onto your crypto assets for over a year can reduce your tax liability and maximize your profits.
Recognizing the Wash Sale Rule in Crypto Taxes
Crypto taxation can be complicated, and it is important to understand the different rules and regulations that apply to digital assets. The wash sale rule is a tax regulation that prevents individuals from claiming a loss on an investment and purchasing back the same asset. If you sell a crypto asset at a loss and then repurchase the same or a substantially identical asset within 30 days, the loss will not be recognized for tax purposes, which can significantly impact your tax liability and result in an unexpected tax bill.
To avoid violating the wash sale rule, you should wait at least 31 days before purchasing the same or a substantially identical crypto asset. Alternatively, you can invest in a different cryptocurrency or digital asset that is not considered substantially identical to the one you sold. With the help of Accointing, investors can easily identify which positions to sell, when to sell them, and when to buy them back to avoid potential penalties.
Top 5 Ways to Boost Profits and Reduce Crypto Taxes
Once you understand the basics of crypto taxation, you’re in a good position to start exploring legally-acceptable strategies to reduce your crypto taxes.
Reporting Crypto Losses
One of the most effective ways to reduce your tax liability on crypto investments is to report crypto losses. Capital losses can be used to offset capital gains and reduce your overall tax liability. You can carry the excess loss to future tax years if your capital losses exceed your capital gains.
For example, if you sell crypto for a loss of $5,000 and have capital gains of $3,000 from other investments, you can offset the $3,000 with the $5,000 loss, resulting in a net loss of $2,000. You can then carry forward this $2,000 loss to offset future capital gains.
Take Profits in Low-Income Years
Taking profits during low-income years is a smart crypto tax strategy to boost your profits while minimizing your tax bill. It involves selling some crypto assets during a year when your taxable income is lower than usual. This allows you to lock in gains and pay a lower capital gains tax rate than during a high-income year.
For example, if you have a year with less income due to a job loss, retirement, or taking a sabbatical, it may be a good time to sell some of your crypto assets. If you hold the assets for more than a year, you may qualify for the long-term capital gains tax rate, which is generally lower than the short-term capital gains tax rate. However, remember that the sale of assets will trigger a taxable event. That’s why using a reliable crypto tax calculator is essential to estimate the potential tax liability from selling crypto assets during a low-income year. By taking advantage of a low-income year, you can increase your profits while reducing your tax bill.
Accointing’s crypto tax calculator can be a valuable tool in helping you determine whether taking profits in a low-income year is the right strategy for you. Our platform will automatically classify and calculate your crypto taxes and identify possible tax-saving opportunities. With the right tools and guidance, you can make informed decisions about your tax strategy and keep more of your hard-earned gains.
Take Advantage of Tax-Free Thresholds
US taxpayers can earn up to a certain amount of income without paying taxes, known as tax-free thresholds. For the tax year 2022, the threshold for a single filer is $12,950, and for married couples filing jointly, it is $25,900.
To minimize tax obligations on crypto investments, investors can sell a portion of their appreciated crypto assets up to the tax-free threshold amount without paying taxes on the gains. This is useful for investors with unrealized gains who want to realize some gains without triggering a large tax bill.
For example, selling $12,950 worth of Bitcoin instead of the full amount of $25,000 would stay below the tax-free threshold and avoid taxes on the gains. Investors can then hold onto the remaining crypto assets until a future year with more tax-free room to sell more assets.
Give Crypto To Charity or Gift It To Family
Crypto donations to a charity or gifts to family members can also be a smart move for reducing taxes and increasing profits. When you donate crypto to a qualified 501(c)(3) organization, you can deduct your donation and do not have to recognize a gain or loss on the disposal of the crypto. If the crypto has been held for more than one year, the donation amount is the fair market value at the time of the donation. If the crypto has been held for one year or less, the donation amount is the lesser of the cost basis or fair market value at the time of donation. However, donors must sign Form 8283 and provide a qualified appraisal for donations of $5,000 or more. This means that you avoid paying capital gains tax on your appreciated cryptocurrency and get a tax deduction that you can use against other ordinary income.
Similarly, gifting crypto to family members can also have significant tax benefits. By gifting crypto, you can avoid paying capital gains tax on the appreciated value of the crypto, and your recipient does not have to pay income tax when they receive the gift. This can be an effective way to transfer wealth to family members while minimizing tax liabilities. It is important to note that certain limits and requirements must be followed when gifting crypto, such as the $16,000 per person annual exclusion limit for gift tax purposes. If the gift exceeds this amount, the donor must file a Gift Tax Return and may owe a tax ranging from 18% to 40% on the excess amount.
Use a Crypto Tax Calculator to Spot Unrealized Losses
A crypto tax calculator can help investors identify unrealized losses in their portfolio. By identifying these losses, investors can sell the asset to realize the loss and offset their capital gains. Tax Loss Harvesting is a simple strategy that involves selling crypto assets with unrealized losses to convert them into realized losses. For example, if you buy a crypto asset for $10,000 and its current value is $8,000, you can sell it to realize the loss of $2,000 and offset other capital gains.
However, it can be challenging to determine which assets to sell and which are in a loss position, and only a few tools can do this effectively. The Tax Loss Harvesting Tool provided by Accointing makes this process easier by breaking down your assets into wallets and tax lots, ordered by earliest to most recent, and providing data on the potential tax impact of each position. With our tool, you can identify unrealized losses in your coins and sell the ones that will generate the most significant loss, thus minimizing your tax bill.
How Can Accointing Help With Crypto Taxes?
Accointing is a powerful, user-friendly crypto tax software that simplifies the process of tracking cryptocurrency transactions and filing taxes. Here’s why using Accointign to help you report your crypto taxes is a good idea:
- Easy Integration with Multiple Exchanges and Wallets: With 400+ blazing fast integrations across exchanges, wallets, blockchains, and services, including Binance, Coinbase, Kraken, and more. You can connect your accounts to Accointing and automatically import all your transactions, eliminating the need to enter each transaction manually.
- First-in-Class Crypto Portfolio Tracking & Insights Tool: In addition to its robust tax features, Accointing also offers a first-in-class crypto portfolio tracking and insights tool. From Accointing’s portfolio dashboard, you can deep-dive into your transactions and have your entire crypto portfolio at a glance. The dashboard summarizes your buy and sell dates, net profit, and overall gains, allowing them to track it all in real-time.
- Accurate Calculation of Cost Basis and Capital Gains/Losses: Calculating the cost basis and capital gains/losses for cryptocurrency transactions can be challenging, especially for investors with a high volume of transactions. We have created the most accurate crypto tax calculator for US crypto investors. Whether you’re into DeFi staking, margin trading, or mining, Accointing will automatically calculate the cost basis and capital gains/losses based on your preferred tax method (FIFO, LIFO, and HIFO).
- Additional Tax Tools: We offer a Trading Tax Optimizer, which predicts the tax implications of your trades before you execute them, allowing you to meet your tax goals. Also, our previously mentioned Tax Loss Harvesting Tool will identify unrealized losses in your portfolio for you to sell the assets and offset your capital gains.
- Generation of Tax Reports: Our platform generates fully compliant Crypto Tax Reports that include a summary of all your taxable trades and income, as well as supplementary files such as Form 8949 in both PDF and CSV formats to assist you in completing your Form 8949, gains and losses CSV files, a daily balance report, and import files for tax tools such as TurboTax.
- Dedicated Customer Support: Accointing offers dedicated customer support to help you with issues or questions about the platform or their crypto taxes. You can contact the support team via email, live chat, or the help center and expect a prompt response.