3 Ways to Minimize Your Bitcoin Taxes
If you’re like most people, you don’t enjoy the process of paying and completing your taxes every year. It’s tedious and time consuming. When the world of tax reporting is combined with bitcoin and cryptocurrency trading, this chore becomes even more painful. However, it can still pay dividends to learn the ins and outs of cryptocurrency capital gains reporting so that you can understand how to minimize your tax liability for the year. This article discusses three of the most popular ways to do so.
1. See if you can use a specific identification costing method rather than FIFO
You only need to report your crypto gains and losses on your tax return—not all of your owned crypto. You owe crypto taxes on your gains (as they are a form of income), while your losses will reduce your overall tax liability. When calculating your gains and losse for each trade, the most common approach is to use the first-in first-out method, you are selling the coins you acquired earliest first.
However, after the new IRS crypto tax guidance came out in October 2019, it clarified that specific identification costing methods outside of FIFO could be used when calculating your gains and losses for your cryptocurrency transactions provided that you had records to specifically identify your crypto.
In using this strategy, you want to specifically identify and “sell” the cryptocurrencies that you bought at the highest price first. For anyone investing significant amounts of money, this slight change in calculations can lead to huge tax savings. Cryptocurrency tax calculators are especially good at applying these tax minimization algorithms like HIFO (Highest in first out) and LIFO (Last in first out).
One thing to make sure of before using a specific identification method, is that you are able to actually specifically identify a unit of crypto.
To specifically identify a unit of cryptocurrency, you must have records of 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 tax bill.
2. Invest for the long term – HODL
Similar to stocks, when you sell cryptocurrency that you’ve held for more than one year, the associated gains are taxed at the long-term capital gains tax rate, which is less than the short term capital gains rate. This incentivizes long-term investment, and it offers a great way for crypto investors to minimize their tax bill.
Take account of your cryptocurrency portfolio and look at when you first acquired each of your coins. If you have a huge capital gain in one of the assets in your portfolio, it could be wise to figure out how long you need to hold it to qualify for the long-term capital gains tax rate.
3. Move your crypto to a retirement account
Retirement accounts like IRA’s and 401-K’s are popular investment vehicles. These types of accounts come with tax incentives that can help shield profits from the tax man. By using a retirement account like a self-directed IRA to purchase cryptocurrencies, you can defer paying tax (sometimes you can even pay none at all).
This is contrary to using a traditional cryptocurrency exchange where the income generated from selling or trading crypto is taxed during that same year. Cryptocurrency IRA’s can be an effective tax reduction tool—especially if you believe in the long term value of cryptocurrencies.
Keep in mind that there is a deadline to open and contribute to your self-directed cryptocurrency IRA. The period in which you can make a contribution for a given tax year is from January 1 of that year until you file your tax return. Contributions cannot be made after your filing deadline (i.e., April 15 of the following year).
There are a lot of best practices when it comes to tax minimization. These are just a few of the options you can leverage to help reduce your overall tax liability for your crypto portfolio. It’s always important to keep as accurate of records as possible so that you can take advantage of each of these options.