Every one of us who is either trading/investing or planning to do so in Bitcoin or altcoin must have a clear idea of the taxes we have to pay/report every year. It is a cumbersome task to report the gains/losses we make on our crypto trade.
The complexity in the process also makes us wonder whether there are any legit ways of minimizing the tax liability on our bitcoin and other cryptocurrency gains. In this article, we will discuss some of the tips and tricks that can help you minimize your Bitcoin and cryptocurrency taxes.
Without further ado, let’s discuss the wayouts of minimizing our crypto taxes:
1. Open a Retirement Account: Either a Crypto 401(k) or IRA Account
In the world of investing, there are two popular vehicles that help in saving taxes. They are the retirement accounts such as 401(k)s and IRAs. These are investment accounts that come with tax incentives, thereby protecting your investment gains from the taxman.
As a cryptocurrency trader and investor, you can open a self-directed IRA and retirement account for buying cryptos. This account will help you defer tax. Sometimes, you don’t have to pay anything at all.
Opening of such a retirement account is completely different from a traditional cryptocurrency exchange where the gains earned from buying and selling cryptocurrencies are taxed during the same year. Cryptocurrency IRA retirement accounts are an effective tool for Bitcoin and crypto investors to reduce taxes, especially if you believe in the long-term value of cryptocurrencies.
Always remember that you have to open and contribute to your self-directed cryptocurrency IRA retirement account within a certain deadline. For a certain tax year, contribution to the concerned self-directed retirement account must be done within January 1 of that year until the tax return is filed. This means you can’t make any contribution to the account after the filing deadline, which is usually April 15 of the following year.
2. Use Specific Identification Costing Method
In October 2019, the new IRS cryptocurrency tax guidance has been laid out. This guidance clearly identifies specific identification costing methods to calculate gains and losses for cryptocurrency transactions. However, this specific identification costing method for saving taxes can be applied only if you have adequate records for specifically identifying your cryptocurrencies.
The most common method used by the crypto traders and investors pre-2019 was known as First In, First Out (FIFO) calculation method. This method calculates gains and losses from their trades on the basis of when the cryptocurrencies are first bought and sold. Crypto investors used this method because it was not made clear earlier by the IRS whether a specific ID was allowed or not.
However, now IRS has laid out new guidance for cryptocurrencies, which makes it clear that crypto gains can be reduced through specific identification. The best thing about the newly laid Specific Identification Costing Method is that you can specifically identify the cryptos that you had purchases at the highest price first. This slight but significant change can save hundreds and thousands of US Dollars for active crypto traders.
You can use cryptocurrency tax calculators for applying these tax minimization algorithms such as HIFO (Highest In, First Out) and LIFO (Last In, First Out). However, you’ll have to specifically identify a unit of cryptocurrency as per the IRS outlines so that you can use a specific identification method. Therefore, you must have records of the following information:
- Date/time of each cryptocurrency unit acquired
- Each crypto unit’s basis and fair market value at the time of its acquisition.
- Date/time when each cryptocurrency unit is sold/exchanged/otherwise disposed of.
- Each crypto unit’s fair market value when it is sold/exchanged/otherwise disposed of.
- Value or amount of money received when each unit of the cryptocurrency is sold/exchanged/otherwise disposed of.
All the above-mentioned information can be used for using any one of the specific identification methods (HIFO or LIFO) for lowering your cryptocurrency capital gains taxes drastically.
3. Hold Cryptocurrencies for More Than One Year
When you hold a cryptocurrency for more than one year, the long-term capital gains tax rates become applicable, which are typically much lower than the short-term capital gains tax rates (which becomes applicable when your Bitcoin/altcoin’s holding period is less than one year).
When you identify your cryptocurrencies specifically, you can specify which are the crypto coins that you have held on to for more than one year. This qualifies you for the long-term capital gains rate, thereby helping you to reduce your overall tax liability significantly.
4. Invest Your Cryptocurrency Capital Gains into a Qualified Opportunity Zone Fund
With the introduction of the Tax Cuts and Jobs Act of 2017, the Opportunity Zone Funds have now become a part of the tax code.
What is an Opportunity Zone? IRS defines it as “an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.”
When an investor invests funds in these qualified Opportunity Zone Funds, the communities on the receiving end of these funds benefit from revitalization. This, in turn, helps the investors in terms of tax benefits when they invest in these funds.
If you invest your crypto capital gains in one of the qualified Opportunity Zone Fund within 180 days of the sale of the crypto, you can defer capital gains taxes on that amount until the Opportunity Zone Fund investment is sold/exchanged or until December 31, 2026 (whichever comes first).
The Bitcoin and crypto investors who have large amounts of capital gains can reduce their tax bills significantly by investing these gains into such a qualified opportunity zone fund.
How can you
Simplify your Tax Filing, Minimize Crypto Tax, and Optimize Net Income
You can use Cryptocurrency Tax Software for making the entire process easier. Just plug your trade history into a bitcoin and cryptocurrency tax software, which minimizes your overall tax by optimizing your gains and losses. Simply import your crypto trading history into the concerned software, its programs will generate your tax reports with the click of a button. You can get your crypto report ready in a matter of seconds and consequently minimize your Bitcoin and cryptocurrency taxes.
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