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Tutorial: How To Reduce Your Crypto Taxes in 4 Easy Steps

January 03, 2020

Crypto trading has been at an all-time high in 2018. But the increasing popularity of crypto trading comes with a note of caution — it's important to stay on the right side of the IRS. A guidance note issued by the IRS on crypto taxes is still the definitive document as far as crypto taxes are concerned. The IRS now seems to be doubling down on crypto tax evaders and is even sending letters of warning.

This is the right time to examine your crypto tax filings to make sure everything is in order, and file amended returns if required. While it's important to pay your taxes correctly, there are some perfectly legal steps you can take to minimize your tax liability.

Step 1: Tax-loss harvesting — the smartest technique to reduce your tax debt

Let's say you've made significant profits from crypto trading this year. However, the value of the crypto you currently hold is extremely low. A smart idea would be to sell the crypto at the low price, triggering capital losses that you can then use to offset the gains you've made throughout the year, thereby reducing your tax liability. You can not only offset all your capital gains but also use those capital losses to offset up to $3000 of ordinary income.

If you want to continue holding onto your crypto in the hope of long-term appreciation, you can simply buy it back after a few days. Luckily, the IRS considers crypto as "property". This means that the "Wash Sale Rule" that prohibits people from offsetting capital gains if they repurchase stock or security that was sold for a loss in the last 30 days, doesn't apply to cryptocurrencies.

Step 2: Hodling & borrowing — stay invested for over a year

Your tax liability is obviously significantly lower if you're invested for the long term. If you sell crypto within one year of purchase, it triggers short-term capital gains tax which usually works out to be much higher than long-term capital gains tax. So it definitely makes sense to hold onto your crypto for more than a year.

Of course, you may argue that unlike real-estate and other property, crypto is extremely volatile. So the major gains can only be made through smart, short-term trades. A smart way to solve this issue is to borrow money against your crypto assets instead of selling them outright. You can use lending platforms to get instant access to cash without selling your crypto and triggering short-term capital gains tax. The interest rates on these credit lines are usually much lower than the tax rates. However, they do tend to pile up in the long run so it's important to be aware when taking this route.

Step 3: Take advantage of those amazing tax rebates with your retirement account

If you buy crypto as part of a retirement plan, using your IRA (Individual Retirement Annuity) or 401-K, then you don't need to pay taxes until you actually start taking distributions. This means that your crypto account can keep growing over a long period of time without having to withdraw money to pay taxes. In fact, if you have a Roth IRA, you don't need to pay capital gains tax at all, even when you withdraw the amount.

Step 4: Keep accurate records of your crypto trades

One of the things most crypto traders fail to remember is that taxes are calculated based on the difference between the price of the crypto on the day of purchase and the day of sale. This becomes even more complicated when the crypto is a gift or has been received in lieu of salary or as income from mining or staking. In this case, the purchase price is deemed to be the fair value of the crypto on the day it was received.

Since most crypto traders undertake multiple trades in the year, it becomes very important to keep an accurate record of the transactions, and the price at which they were made. This is because major exchanges like Coinbase only issue a tax form statement to users who have realized gains in excess of $20000 and undertaken more than 200 transactions. If you haven't kept an accurate record so far, it's a good idea to use crypto tax software that can extract your data from the exchanges and create accurate tax documents.

One last word

Use these tips early in the year so that you can plan your taxes. If you're not sure about how to prepare your tax returns, consult a crypto cpa. While this may seem like an expensive option, the money you save on your taxes will be worth it.

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