When it comes to strategic tax planning across the majority of investable assets like stocks, bonds, real-estate, etc., December is the busiest month. This of course is because December is the final month of the calendar year, and many countries, like the U.S., run their tax season on a calendar year basis—even though your taxes aren’t actually due until April 15th the following spring. This type of tax planning is no different for the asset of cryptocurrency, which is considered property for tax purposes just like stocks or bonds. In this article we’ll discuss five strategies you can use prior to Dec. 31st to help strategically lower your crypto tax liability.
1. Tax Loss Harvesting
For most cryptocurrency investors, the single most effective way to reduce their crypto taxes and put some money back in their pocket is through tax loss harvesting.
Tax loss harvesting is the practice of selling a capital asset at a loss to offset a capital gains tax liability. By realizing or “harvesting” a loss, investors are able to offset taxes on both gains and income. This is a tax reduction strategy commonly used in the world of stocks and securities, and it can also be applied to cryptocurrency.
Let’s say Steve buys $1,000 of BTC and $2,000 of ETH in a given year. While holding these investments, the value of Steve’s BTC rises to $1,500 while ETH drops to $1,700. Steve sells all of his BTC for a gain at the $1,500 price.
Without Tax Loss Harvesting
Without harvesting his losses in ETH, Steve has a $500 capital gain for the year from the sale of his BTC. Steve pays taxes on all $500 of this capital gain.
With Tax Loss Harvesting
Rather than continuing to hold his ETH, Steve can harvest his losses in ETH by selling before year-end. Capital gains and losses get summed together for the year resulting in either a net gain or loss. Steve’s net capital gain is now only $200 for the year ($500 – $300). In this scenario, Steve only pays taxes on $200 of net capital gains rather than $500.
Of course this is a small scale example, but for many cryptocurrency traders, there can be enormous tax loss harvesting opportunities that exist within their crypto portfolios. The key is identifying which of your held assets have declined in value significantly from when you originally acquired them. Crypto tax calculators have built in tax loss harvesting tools to help you automatically identify which assets within your portfolio present the largest tax savings opportunities.
2. Hold for longer than 1 year
If tax loss harvesting isn’t an option, the next best thing is to hold your crypto investments for longer than one year—if you expect to realize capital gains. Similar to the world of investing in stocks, holding onto an investment for longer than one year pushes you out to the long-term capital gains tax rates. These are typically much lower than the short-term capital gains tax rates which apply when you have sold are traded out of your investment after holding onto it for less than one year.
3. Give away cryptocurrency as a gift
No this is not a suggestion that you give away all of your cryptocurrency. Gifts under a certain amount aren’t taxed. Currently, you can give away up to $15,000/year without incurring a taxable event. While this might seem like a drastic way to avoid tax, if you want to share your wealth with family and friends, making gifts in cryptocurrency could be a great way to do so.
4. Buy and sell with a crypto 401-K or IRA retirement account
Okay, this one sounds a bit more complex, but it really isn’t. By using a retirement account like a 401-K or IRA to purchase cryptocurrencies, you can defer paying tax (sometimes you can even pay none at all). All of the income you realize within the 401-K account will be tax deferred. This is contrary to using a traditional cryptocurrency exchange where the income generated from selling or trading crypto is taxed during that year. Crypto IRA’s can be an effective tax reduction tool—especially if you believe in the long term value of cryptocurrencies.
5. Use a specific identification costing method
After the new IRS cryptocurrency tax form and tax guidance came out in October 2019, it clarified that specific identification costing methods could be used when calculating your gains and losses in crypto provided that you had records to specifically identify your crypto.
To specifically identify a unit of cryptocurrency, you must include the following information:
- The date and time each unit was acquired,
- Your basis and the fair market value of each unit at the time it was acquired,
- The date and time each unit was sold, exchanged, or otherwise disposed of, and
- The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit
If you have this data for your transactions, you are able to use specific identification methods like LIFO or HIFO which can drastically lower your cryptocurrency taxes.
December is here, so make sure you take some time to analyze your crypto portfolio and use some of these tactics to reduce your overall tax liability. Once April 15th rolls around, you will be happy you did! Especially if it winds up saving you thousands of dollars.
David Kemmerer is the Co-Founder and CEO of CryptoTrader.Tax, a tax reporting software suite for cryptocurrency investors.