W2s and 1099s were sent out, and the tax season here in the United States is finally in full swing. For those operating in the world of bitcoin or altcoin investing, this time of year may have added stress as reporting gains and losses can be a cumbersome task for your crypto trades. Although reporting can often be daunting, there are many things you can do to help mitigate your bitcoin and other profits from cryptocurrencies, and your tax liability, in turn. This article addresses some of those tricks and tips.
Open a Crypto 401(k) or IRA Retirement Account.
Retirement plans such as IRAs and 401(k)s are standard automobiles used in the investment world. These forms of investment accounts come with tax benefits which can help protect the tax man’s income. You can avoid paying tax by using a retirement account such as a self-directed IRA to buy cryptocurrencies (sometimes you can even pay none at all).
As opposed to using a conventional exchange of cryptocurrency where the revenue earned from selling or exchanging crypto is taxed within the same year, Cryptocurrency IRAs can be a useful tool for tax reductions — especially if you believe in cryptocurrencies’ long-term worth.
Keep in mind that there is a deadline to open your self-directed cryptocurrency IRA and contribute to that. The period in which you will donate for a specific tax year is from January 1 of that year before your tax return is filed. You can not make donations beyond the filing date (i.e. April 15 of the following year.
Look into Using a Specific Identification Costing Method
Following the publication of the latest IRS cryptocurrency tax guidance in October 2019, it explained that unique identification costing approaches could be used when estimating your profits and losses for your cryptocurrency transactions if you have documents explicitly describing your crypto.
That sounds far more complicated than it is. Essentially, pre-2019, most Bitcoin and crypto investors used the standard First In, First Out (FIFO) calculation method to calculate their gains and losses from their trades (the cryptocurrencies you first purchased will be sold first) because the IRS had not yet specified whether specific IDs were allowed. Now that the new guidance makes this clear, a great way to reduce your gains is to identify precisely.
By using this strategy, you want the cryptocurrencies you first purchased at the highest price to be specifically identified and “sell” This slight change can result in substantial tax savings for the active traders.
Cryptocurrency tax calculators are particularly good at applying such algorithms of tax minimisation as Highest In, First Out (HIFO) and Last In, First Out (LIFO).
Before you can use a specific identification method, however, you must be able to identify a cryptocurrency unit as outlines for the IRS specifically
To identify a cryptocurrency unit specifically, you need to have records of the following information.
Date and time of purchase of each unit;
Your basis and the fair market value at the time each unit was acquired;
Date and time of sale, exchange, or otherwise disposal of each unit; and
Each unit’s fair market value when it is sold, exchanged or disposed of and the amount of money or the value of the property received for each unit.
If you have this data for your transactions, you can use specific identification methods such as LIFO or HIFO that can drastically lower your capital gains taxes on crypto-currency.
Hold on longer than a year
As the world of investing in stocks, hanging onto a cryptocurrency investment for more than a year takes you out of the tax limit on long-term capital gains. These usually are significantly lower than the tax rates on short-term capital gains that occur when you have sold or traded out of your investment after holding on for less than a year.
Additionally, if you are able to classify the cryptocurrencies clearly, you can further leverage this technique. It would be best if you decided that the coins you “sell” are the coins you keep for a period of more than one year. That will qualify you for the rate of long-term capital gains and help to reduce your total tax liability!
Invest your Crypto Capital Gains in a Fund for Eligible Opportunities
With the 2017 Tax Cuts and Jobs Act, Opportunity Zone Funds become a part of the tax code. The IRS describes an Opportunity Zone as an “economically disadvantaged neighborhood where new investments may be eligible for preferential tax treatment under certain conditions.” Simply put, the communities on the receiving end of these funds benefit from revitalization while investors benefit from investment tax benefits.
When an investor sells a capital gain-generating asset, he or she can roll any amount of the gain into an Opportunity Zone Fund within 180 days of sale. The investor will then postpone the capital gains tax on that number until December 31, 2026, or until the investment in the Opportunity Zone Fund (whichever comes first) is sold or exchanged.
For Bitcoin investors who have substantial sums of capital gains, rolling those gains into an investment opportunity fund can be an effective tactic to lower the tax bill.
Use Cryptocurrency Tax Software
Finally, plugging all of your trading backgrounds into a cryptocurrency tax app is one of the easiest ways to optimize your tax savings on your crypto-investment. Bitcoin and crypto tax software systems provide built-in tools to evaluate and maximize the tax minimization gains and loss reporting. Importing your trading history is as simple as linking your exchange accounts for the cryptocurrency. These systems can then create your tax records with the click of a button once your historical trades are in.