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 retirement accounts such as 401(k)s and Roth 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 rothIRA and retirement account for buying crypto assets. This account will help you defer business income tax deductions. 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 asset investors to reduce earned income 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 income tax return is filed. This means you can’t make any contribution to the account after the tax filing deadline, which is usually April 15 of the following year.
2. Use Specific Identification Costing Method
In October 2019, the new IRS digital currency income tax rates deductions guidance was 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 cryptocurrency traders and investors pre-2019 was known as First In, First Out (FIFO) calculation method. This method calculates gains and losses from their cryptocurrency 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 the IRS has laid out new guidance for cryptocurrencies, which makes it clear that crypto asset 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 purchased at the highest price first. This slight but significant change can save hundreds and thousands of US Dollars for active cryptocurrency traders.
You can use digital currency tax treatment calculators for applying these earned income tax rates 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 digital currency 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 short term capital gains taxes drastically.
3. Hold Cryptocurrencies for More Than One Year
A big tree don’t grow in one year. Try to seed big trees with your investments.
When you hold a cryptocurrency for more than one year, the long-term capital asset 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 onto for more than one year. This qualifies you for the long term capital gains rate, thereby helping you to reduce your overall tax rates liability significantly.
4. Invest Your Cryptocurrency Capital Gains into a Qualified Opportunity Zone Fund
With the introduction of the Tax rates 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 asset, you can defer short term 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 asset 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 Taxes, and Optimize Net Income?
You can use Cryptocurrency Tax guide or tax software for making the entire process easier. Just plug your trade history into a bitcoin and digital currency income tax software, which minimizes your overall tax deductions by optimizing your gain or loss. Simply import your crypto trading history into the concerned tax software, its programs will generate your earned income tax deductions 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.
As you can decrease your crypto taxes, you should give more emphasis on earning more from your cryptocurrency investment. The best way to achieve your goal of achieving optimal income tax return (as per your risk appetite), you can use AI-driven Cryptocurrency Trading Robots (that are cloud-based platforms on which you can connect to major exchanges such as Binance, Bitmex, Bitfinex, OKEX, Kraken, Bitstamp, and Bitpanda). You can put such a crypto bot on autopilot. It’ll scan the market value automatically in real-time and trade on your behalf by removing fears and emotions from their trading.
Smart crypto asset investors always remain prepared to get the best of a big market move. They don’t wake up suddenly. To remain alert round the clock, they use digital currency trading bots so that they don’t miss any big market value movement.
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