Every time you sell or trade cryptocurrencies, you may have to pay taxes. However, there are various simple techniques and strategies to minimize the amount of taxes you have to pay. This article will look at some of the ways to lower your crypto taxes in 2020.
Deploy Tax-Loss harvesting
One of the most powerful yet underutilized ways to reduce your crypto taxes is tax-loss harvesting. As you pay taxes only on your “net capital gains”, Tax Loss harvesting allows you to offset your gains by selling your losing positions. Essentially, you can sell any cryptocurrency you own that has decreased in value. This sale will help you realize a “capital loss”. You can subtract this loss from your gains to reduce your net capital gain. Thus, you are able to decrease your tax obligations.
Tax Loss harvesting isn’t just specific to crypto; it is frequently utilized while trading securities. However, Wash Sale rules prevent investors from immediately buying back the stocks that they sold to realize a loss. They need to wait 30 days before they can do so. However, because cryptocurrencies are treated as “property” and not a security, Wash Sale rules likely do not apply to cryptocurrencies today.
Carry Over Your Crypto Losses
This strategy is based on a similar principle to tax-loss harvesting. If you have capital gains from other capital assets, you can use the losses you incurred in crypto to offset those gains as well.
For example, let’s say you made $1500 from selling Tesla stock, but you lost $5000 on your crypto trading (mis)adventures. Thankfully, there is some respite for you as your net capital loss is $3500. Thus, you can deduct $3000 of losses from other income this tax year.
Why $3000 and not $3500? Because you can only claim a maximum net capital loss up to $3,000 in any given tax year. However, you can carry the excess to the next year! This means you will be able to deduct the remaining $500 as capital loss next tax year.
Have a Long Term ‘Hodl’ Strategy
Ardent cryptocurrency fans will tell you ten thousand reasons why you should ‘Hodl’. But it seems that the IRS is also ‘Hodl Gang’. Well not really, but the capital gains rates are lower for investments held for over a year than the taxes on investments held for less than one year. Your capital gains rate can even reach 40% if you own your cryptocurrencies for less than one year! In the case of long term capital gain tax, you can even manage to get this to 0%. You can check your rates here. The rate will depend on your income and filing status. But the rate is always lower for long term capital gains.
Trade With Your IRA or 401-K
Investment accounts such as 401(k) plans, individual retirement accounts (IRA), 529 college savings accounts, etc. usually have tax benefits. They allow your gains to be tax-free or tax-deferred to incentivize retirement savings. However, you can’t hold cryptocurrencies in traditional IRAs and Roth IRAs. You will need to set up a self-directed IRA (SDIRA). There are various platforms that offer SDIRA for cryptocurrencies. Purchasing your crypto via your SDIRAs will help you reduce your taxes significantly. Especially if you wish to keep your crypto for the long term.
Donate to Charity
You don’t need a crypto tax reduction guide to tell you to consider donating to causes you care about. But to make the deal even sweeter, cryptocurrency donations are regarded as a “non-taxable event”. You won’t need to pay any capital gain tax on these coins. You can also deduct it to offset other gains or income.
Like trades, crypto donations vary based on whether they are long-term or short-term holdings. For short-term investments (12 months or less) the deductible amount is the lesser amount between fair market value or cost basis. For the long-term, the deductible amount is the fair market value of the donated cryptocurrency.
When you donate, the charity foundation will receive the full amount as this gift is a non-taxable event for them as well. Effectively, you save on taxes, donate to a worthy cause, and ensure the charity receives more funds. Donating in capital assets rather than in traditional fiat is a better option for all parties.
Use HIFO Accounting Method
Another useful strategy is to optimize your calculation method when calculating your gains and losses. For many years there wasn’t much clarity on which calculation methods were allowed for cryptocurrencies, so traders defaulted to FIFO (first-in, first-out) which is essentially reporting your trades strictly in chronological order.
With new guidance released in 2019, the IRS is now allowing specific identification methods, which allows you to “sell-off” assets in a different way rather than just chronological order. HIFO (highest-in, first-out) is now an acceptable method if you can prove that you’re tracking your assets according to IRS standards.
With HIFO, you sell or take out the cryptocurrencies that you bought at the highest price first. For example, let’s say you bought 1 BTC for $9K in July 2020, and another BTC for $17K in November 2020. If you sell 1 BTC in December 2020 for $20k, then which BTC gets counted as sold off “first”?
With FIFO you would count the earliest acquired BTC as the one being sold.
20,000 – 9,000 = 11,000 Capital Gain
With HIFO you could count the BTC with the higher cost basis as the one being sold, which will yield a lower gain.
20,000 – 17,000 = 3,000 Capital Gain
So by using HIFO, you have the potential for the lowest capital gains and the highest capital losses. However, you must be able to specifically identify particular units of cryptocurrency. This means you need to keep a detailed record of all your crypto trades and transactions to justify your use of HIFO calculation methods.
Leverage Crypto Tax Software
Calculating crypto taxes is complicated. Doing it manually can quickly become a nightmare. Especially if you are an active trader or have a lot of transactions and trading activity. You have to meticulously document your buy/sell dates, identify each unit, specify the amounts, use the right fair market value, and then calculate your capital gains.
Crypto tax software such as CryptoTrader.Tax can automate your entire cryptocurrency tax reporting process. These tools can also apply various tax minimization strategies to ensure that you pay the lowest amount of crypto taxes while complying with all the regulations.