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Cryptocurrencies are becoming more important and relevant for both short and long-term investments. Numerous countries around the world are looking at ways to adapt, regulate, and tax them.
In the United States, the Internal Revenue Service (IRS) classifies crypto assets as property. Bitcoin falls under the same regulation. So, when you sell, trade, or exchange BTC into USD or other cryptos, you have to pay a tax on the profit, if there is one.
If you are looking to minimize or even eliminate your crypto tax rate, these strategies should come in handy!
1. Benefit from 0% Tax Rates on Donations and Long-Term Capital Income
If you are a US citizen, you may benefit from a 0% tax rate that applies to long-term capital gains.
To be eligible for this tax deduction, you have to provide information about:
- Your filing status
- Your annual income
- Asset storage time between purchase and sale
For example, if you are married and your partner files your taxes jointly, you may gain a substantial profit in the crypto trade every year without paying any taxes. The value of your revenue will depend on how much money both of you make and for how long you kept those digital assets before selling them.
You can also be eligible for a tax deduction if you donate cryptocurrencies to charity. The main condition is that those assets were in your possession for more than 12 months before the sale. Additionally, if you gain something from donating crypto assets, you do not have to pay income taxes for your profit.
2. Use HIFO to Your Advantage
Highest in, first-out (HIFO) is an accounting instrument for organizing the inventories of an enterprise. It works by taking out of the stock the items that had the highest cost of acquisition. Through this method, you can decrease the taxable income of your cryptocurrency portfolio.
You have to meet several criteria before you can use HIFO and calculate the tax deductions on your cryptocurrency operations. Here they are:
- The exact date and time of purchase for each digital unit
- The fair market value of each digital unit at the time of its purchase
- The exact date and time of sale, exchange, or trade for each digital unit
- The fair market value of each digital unit at the time of its sale, exchange, or trade
- The capital or value received for each digital unit sold, or exchanged, or traded.
You can’t scribble these calculations on a napkin. Instead, you or your accountant will have to use a high-performance computer that keeps the electronic records according to each criterion.
HIFO is an excellent accounting tool for maximizing your gains while paying as small taxes as possible. Fortunately, this method extends to cryptocurrencies and other digital assets, so make sure that you always aim to sell or trade the ones you have paid the higher price per unit.
3. Harvest Tax Losses on Crypto Trades
We mentioned before that cryptocurrencies are considered property by the US law and not stocks or securities. Therefore, they are not taxable under wash-sale rules.
The wash-sale rule states that buyers can eliminate tax loss if they purchase the same security, stock, or option to buy it or a “substantially identical” security within one month before and after the date they sold the investment that generated the loss in the first place.
Instead, trading cryptocurrencies enable you to harvest tax losses, increase your savings, and enhance your investment portfolio.
If you wish to use this method, you can sell the crypto assets that “bleed” in your portfolio. Next, you harvest losses for tax purposes and immediately return to the same position without waiting 30 days. You can then use these harvested losses to balance your cryptocurrency profit and other capital gains.
4. Use Your Self-Directed IRA (SDIRA) for Crypto Operations
This method of reducing the cryptocurrency tax rate is not a way to avoid taxes completely. Instead, it helps you delay taxes on your crypto trades while increasing the savings in your Self-Directed Individual Retirement Account (SDIRA).
If you do not have an SDIRA, you might want to consider one at least as a crutch for your crypto investments.
You can use SDIRA to trade cryptocurrencies through it and increase your crypto revenue without paying taxes on it today. The tax money remains in your SDIRA account, and you can roll it to increase your overall return in the long run.
When you retire, you will eventually have to pay taxes for your crypto operations. However, by that time, you will be subject to a lower tax rate, and your crypto profits should have a substantial margin on the tax money you send to the IRS.
5. Use a Quality Opportunity Fund (QOF)
If you are one of the select few high-net-worth taxpayers and you have a substantial annual profit from crypto trades, this method will suit you perfectly.
All you need to do is roll over your long-term crypto profits into a Qualified Opportunity Fund (QOF). This investment vehicle is specifically programmed to help you invest in areas known as “opportunity zones.”
Opportunity zones are particular geographic regions declared by the government as economically afflicted. Investing in these areas qualifies you for significant tax reductions on capital gains.
This strategy should help you get rid of your crypto tax rate in the long run. You can avoid capital gains taxes on your crypto trades entirely if you hold your investment in a Qualified Opportunity Fund for 10 years or more. Even when you hold for just 5 years, you will not have to pay taxes on 10% of your initial crypto tax profit.
So, there you have it! These are just five legal and convenient ways of reducing your crypto tax, and in some cases, even eliminating it.
Disclaimer: This is an informational article, and it does not stand for professional tax advice. To better manage your taxes on cryptocurrency and other digital assets, we recommend that you consult with a certified public accountant (CPA).