With the ever-expanding crypto market, a large number of investors are now entering the crypto world, and these investors are generating profits. But in addition to making profits, it is important to understand how crypto taxes work in the U.S. and the continuously changing regulations of the IRS.
In our latest article, we'll learn how crypto taxes work and also explore 9 tried-and-tested strategies to minimize cryptocurrency taxes.
Crypto Taxes 101
The Internal Revenue Service (IRS) has categorized virtual currency or crypto as property and not currency and is thus taxed accordingly. This implies that, just like traditional assets like stocks and bonds, cryptocurrency would now qualify for capital gains treatment.
The factors that determine crypto asset gains are:
- Crypto holding period
Certain activities such as earning crypto interest from DeFi lending, block rewards from mining cryptocurrency, and a few others are categorized as income and therefore considered income tax.
Your crypto holding period begins the day after you've made a crypto transaction or purchased a cryptocurrency asset and continues till the day you've traded, sent, or sold that asset. On the basis of the holding period, there are two types of cryptocurrency capital gains: long-term or short-term.
Long-Term Capital Gains
If your coins have a holding period that exceeds 366 days, they are categorized as long-term capital gains tax rates. There is a 0-20% tax liability in this case and is dependent on your ordinary income tax rate.
Short-Term Capital Gains
Holding your coins for a period of 365 days or less will be considered a short-term capital gain. This is taxable as ordinary income.
Crypto Taxes: Taxable Events In The US
As mentioned earlier, taxable activities depend on income (income tax) and holding period (capital gains and losses). Let's look at a few activities under each category.
Taxable Event Based On Income Tax:
- Accepting crypto in an airdrop
- Earnings crypto interest from decentralized finance (DeFi) lending
- Receiving block rewards and transaction fees by Bitcoin mining
- Receiving payment in the form of cryptocurrency for work done (such as bug bounty campaigns)
- Using staking and liquidity pools to earn crypto
Taxable Event Based On Capital Gains Tax:
- Selling crypto for fiat currency, such as pound sterling, euro, or US dollar
- Swapping (or trading) one crypto asset to another, on exchanges, or directly peer-to-peer
- Purchasing goods and services using crypto
Crypto Taxes: Non-Taxable Events In The US
However, there are certain activities related to crypto-assets that do not have any tax implications, such as gifting, inheriting, or donating cryptocurrencies.
- Donation of crypto to a non-profit organization or a tax-exempt charitable fund
- Purchasing cryptocurrency with cash and holding it
- Transfer of crypto between wallets
- Transferring crypto from an external wallet
Calculating Losses And Gains
Now that you know if your crypto transactions are taxable or non-taxable, it's time to figure out whether you incurred a capital gain or loss on them. For this, you need to review each transaction and keep a record of the cost basis to check whether it's a gain or loss.
Preparing For Tax Season
It is crucial to prepare for tax season beforehand.
1. Keep Records Of All Your Crypto Activity
It is recommended by the IRS to keep accurate accounts of all your crypto activities, like purchases, sales, lending, airdrops, and other taxable activities under capital gains and income tax. You can do this in two ways- use crypto exchanges and platforms with built-in tax reporting facilities to generate reports for you. Or, you can go the extra mile and use third-party services that'll do the same for you.
2. Calculate Your Capital Gain Or Loss
Once you have your report prepared, you can opt for services or tax calculators that'll help you figure out what you owe. You can also choose to do it manually if you've made fewer trades in the year. It is simply calculated by the difference between the selling price and the cost basis.
3. Form 8949 and Form Schedule D
You must fill out Form 8949 in order to report cryptocurrency capital gains and losses. Schedule D, the main tax form, is used to report your overall gains and losses on crypto. If you've earned an income in the form of cryptocurrency it must be included on Schedule 1 Form 1040 and self-employed crypto earnings must be included on Schedule C.
Form Submission & Paying Taxes - What does this connect to?
For any selling or exchange of any capital assets, the transactions must be reported on your federal income tax returns. Form submission is essential as it reflects the property type, date acquired, cost basis, gain or loss, and other essential information that is required for filing taxes.
9 Ways To Minimize Crypto Taxes
A planned strategy can help you minimize your crypto taxes. Here are the top 9 ways you can cut down on your cryptocurrency taxes.
1. Hold On
Your capital gain will depend on your income as well as the holding period of your cryptocurrency. As mentioned earlier, the crypto taxes for short-term and long-term capital gains are 10-37% and 0-20% respectively. So, the key here is to keep your crypto untouched till you convert your short-term gains to long-term gains. This might seem like a difficult task, but it is recommended to keep your asset for one year at the least.
2. Low-Income Year Sales
If you've considered holding onto your capital asset then there's another thing you must keep track of— when will you sell them? Time is a crucial factor to consider because selling in a low-income year can be profitable for you. This will help you in the case of both short and long-term gains.
Short-term gains are taxable as ordinary income. So, when you incur short-term capital gains, your income will not be pushed into a higher tax bracket.
Suppose you’ve retired and are not collecting wages. At this point, if you sell your short-term assets, your tax bracket will entirely depend on your short-term gains.
On the other hand, long-term capital gains mean lower tax rates. How? The tax rates for long-term gains usually range from 0-20% depending on your taxable income. In a low-income year, your taxable income will be less and you might have a lower long-term capital gain rate.
3. Self-Directed IRA To the Rescue
With a Self Directed Individual Retirement Account (SD-IRA) you can pay your taxes when you have a low taxable income in retirement. Or, you can pay them ahead of time if you expect higher taxes during retirement when you initially contribute to your Roth Self-Directed Individual Retirement Account.
4. Gifting Assets
Receiving gifts in the form of crypto will not have any taxable implications until you decide to sell the crypto. In doing so, the cost basis will be the same as the person who gifted it to you. Also, you can gift up to $15,000 crypto per recipient in a year without being liable to pay taxes. On exceeding the said amount, you must file a gift tax return.
5. Donating Assets
If you donate to a 501(3) charitable organization, you are eligible to claim a tax deduction. An appraiser will allocate a fair market value for it depending on the current market price of the coin.
6. Bring Down Your Taxable Income
Another tax minimization strategy is to bring down your taxable income. You can do this by inquiring about the tax code for credit and tax deduction, which will help you in reducing your taxable income.
7. Moving To A Low Or No-Income Tax State
Moving to a tax-friendly state will help reduce or even eliminate taxes. This means that you still have to pay federal taxes, but little-to-no taxes on a state level. Also, you can add up these deductions to save even more on your cryptocurrency earnings.
8. Bring Down Taxable Income
You can opt for other tax minimization options, such as contributing to a traditional IRA account, donating to charities, gifting assets to family members, saving for health accounts, and the likes.
9. Hand Down Crypto As Part Of Your Estate
Bequeathing your crypto assets has a few benefits. At the time of passing away, your investment will receive a step-up or increase based on the fair market value. In this way, your heir does not have to pay crypto taxes on the original investment, when they sell what they inherited. Handing down your crypto assets also helps prevent your investments from getting lost in the digital abyss when you pass away.
The Bottom Line
Dealing with crypto taxes is often considered an onerous task, but not anymore! By keeping the IRS tax rules in mind and keeping a record of your taxable and non-taxable events, you can successfully minimize your cryptocurrency tax.
ZenLedger easily calculates your crypto taxes and also finds opportunities for you to save money and trade smarter. Get started for free now or learn more about our tax professional prepared plans!