Crypto has taken many investors to the moon, but what goes up inevitably comes down, and in the case of crypto gains, tax is the dark side of the moon. Fortunately, there are ways to strategically - and legally - avoid your crypto taxes. Here's how.
The easiest way to avoid paying crypto taxes? You simply need to HODL. This tax avoidance strategy requires you to hold you crypto investment for at least one year before selling. Do this, and in most countries, your gains will qualify for a long-term capital gains rate - a reduction on the rate you'd pay on a short-term gain. In no place is hodling more rewarded than in Germany, where crypto sold after a holding period of one year is tax-free.
Meanwhile, in Australia, a 50% Capital Gains Tax discount is up for grabs, while US crypto investors are also blessed with a reduced capital gains tax rate for assets held more than one year. Here, investors can pay lower tax rates of 0%, 15% or 20%, depending on individual or combined marital income - as opposed to short-term gains, taxed at Federal Income Tax bracket rates, with a maximum tax CGT of 37%.
Take advantage of tax-free thresholds
British taxpayers are in luck. Every individual has an annual CGT allowance of up to £12,300 free of tax. Meanwhile, in Germany, profits under €600 per year are tax-free.
There's no such allowance in Australia unfortunately, but US investors do get a piece of the pie. According to the IRS, if your total income is under $41,676 a year, you'll pay no Capital Gains Tax. For married couples filing jointly, the limit is $83,351 a year. For the head of household, this limit is $55,801 a year. Knowing the tax-free maximums that are available to you is a good way to determine your crypto disposal strategy and hence, actively optimize your taxable position.
Offset gains with losses
As with any investment, you can take advantage of crypto gains by also claiming losses on other investments the year you realize your profit. That means if you made $30,000 for selling Bitcoin but lost $30,000 for selling Ethereum, you wouldn’t owe any tax since you broke even.
These losses aren’t limited to other forms of cryptocurrency, though. If you are about to cash in a large crypto investment, look through the rest of your portfolio to see if there are other losing investments you could sell to offset your gains.
In the US, if your capital losses exceed your capital gains, the amount of the excess loss that you can claim to lower your income is the lesser of $3,000 ($1,500 if married filing separately) or your total net loss shown on line 21 of Schedule D (Form 1040). If your net capital loss is more than this limit, you can carry the loss forward to later years. If you consciously use this to your advantage, this is called tax-loss harvesting.
Invest crypto into an IRA, pension or annuities fund
One of the most effective strategies for avoiding crypto tax is to buy your crypto as part of a retirement, pension or annuities investment.
In the US, self-directed IRAs are special IRAs that allow you to invest in unique assets, such as crypto, real estate and precious metals. Any trading of bitcoin or other cryptocurrencies within the account wouldn't be subject to capital gains tax — taxes would just be triggered when the money is withdrawn.
In the UK, by using a retirement plan like a traditional IRA, Roth IRA or individual retirement account (IRA), you can defer or avoid crypto investment gains entirely, although these plans are far more complicated than regular annuity plans.
Australian investors can enjoy similar benefits from crypto and self-managed superannuation funds (SMSF). Under current SMSF regulation, income is taxed at a rate of only 15% and long-term gains are taxed at an effective rate of 10%. Gains made from crypto assets in a retirement pension are taxed at 0%. A SMSF will need its own wallet, held entirely separate from accounts used for personal cryptocurrency investing.
Use the annual gift tax exclusion
Based in the States? Consider yourself lucky that crypto gifts to anyone, under $16,000 are tax free, unlike in countries like Australian and the U.K.
Instead, American taxpayers enjoy an annual $16,000 gift tax exclusion, which applies to each person you give a gift to. Gifts valued at more than $16,000 would potentially subject you to gift taxes of 40% - but only if you're over the lifetime gift tax exemption of $12.06 million. By strategically gifting cryptocurrency, you can avoid paying capital gains tax on the crypto you dispose of.
Change your tax rate
If you have the luxury of time on your side, you can always try to wait out a lower tax rate. Perhaps you've taken a strategic salary cut, are about to retire, or are headed back to school. If you're able to move to a lower tax rate, timing your crypto disposals to coincide is an effective tax-reduction tactic.
Donate to charity
Yes, your cryptocurrency donation is tax deductible! If you don’t need all of the profit from your crypto investment, you can lower your capital gains tax burden by donating at least some of your crypto to charity. You’ll get a deduction worth the full value of your crypto, including any capital gains - provided the charity is registered.
In the United States, Check a charity's 501(c)3 status with the IRS' exempt organization database. A charity must have 501(c)3 status if you plan to deduct your donation on your federal taxes.
In Australia, you can only claim a tax deduction on donations to organisations with DGR status - deductible gift recipient status.
Offload crypto assets to your spouse
Coupled up? Depending on the country you pay tax in you might be able to offload some of your crypto assets to your husband or wife or civil partner - tax-free. In the UK for example, transfers between spouses is currently exempt from CGT, under a tax-free gift loophole.
This means that the ownership of assets can be transferred between partners so that both of your annual CGT allowances can be used against gains. This effectively doubles the CGT allowance for married couples and civil partners. As per the HMRC, to use this benefit you can't be separated or living apart.
The transfer is said to occur at 'no gain, no loss' because the recipient inherits the base cost of the asset being transferred.
Invest in an opportunity-zone fund
US investors can defer a chunk of their crypto tax bill by investing in an Opportunity-Zone fund. A provision in the 2017 tax law allows taxpayers to defer, and even reduce, capital gains taxes if they put the proceeds from the sale of say, a stock or business, into a fund created to promote investment in an economically disadvantaged area. Investors generally have six months to move the money. Under the rule, you'll also be able to defer your capital gains tax until 2026, and if you hold the investment beyond that, shrink your tax bill by as much as 10%.
In a similar vein, in the United Kingdom any gains made on investments in an Enterprise Investment Scheme (EIS) and Social Investment Tax Relief (SITR) are free from CGT if held for three or more years.
Use a crypto tax calculator to spot unrealized losses
It's unlikely you'll be able to spot crypto tax minimizing opportunities if you don't know how your portfolio is looking. Tax offices like the IRS in America, the ATO in Australia and the HRMC is the UK all recommend that crypto investors use a crypto tax app like Koinly to pay the right amount of taxes. But crypto tax software is just as good at helping you to pay less tax, when you use it strategically.
For example. say you've got a high Capital Gains Tax bill on the horizon. Jump into your portfolio dashboard on Koinly and look at your unrealized losses. If you’ve got assets that are underperforming, you can sell at a loss. This turns them into realized losses, which you can offset against your capital gains to reduce your tax bill. This is also known as tax loss harvesting.
In some countries, you can also offset losses against ordinary income up to a certain amount. Make sure to check your country’s crypto tax laws to see if this is the case where you live.