Yes — taxes are inevitable, and we get why you’d be tired of paying half of your short-term profits and 20% of your long-term gains to the IRS. That’s why we prepared this blog post. Now it’s time to answer the million-dollar question, “how do I avoid paying taxes on Bitcoin?”.
Bitcoin is a relatively new asset class that has created a great deal of profit for early investors. Even though it's a volatile market, crypto investors have made significant profits since the technology's inception.
Like booze or motorcycles, the IRS treats cryptocurrency as a standard type of property. As a result, you have to pay capital gains taxes on property you sell for cash, as well as ordinary income taxes if you exchange or pay money.
Yes — taxes are inevitable, and we get why you’d be tired of paying half of your short-term profits and 20% of your long-term gains to the IRS. That’s why we prepared this blog post.
Now it’s time to answer the million-dollar question, “how do I avoid paying taxes on Bitcoin?”.
You may have already purchased some cryptocurrency. If so, you'll eventually have to determine when to cash out on the cryptocurrency boom. But before you get there, you need to plan how you'll handle crypto taxes.
That’s right — you owe taxes on all income you earn abroad if you are a US citizen.
Investing in cryptocurrency is popular among most people. The Internal Revenue Service (IRS) classifies cryptocurrency as a capital asset under the current virtual currency guidelines.
Which essentially means that you pay capital gains tax on it.
There is no reason why you wouldn't want to reduce your crypto taxes to boost your gain and keep as much of your money as you can. But before learning about different methods you can use to avoid bitcoin taxes, you need to have a solid idea of how you’re taxed.
In a nutshell, cryptocurrency holdings can be taxed in two ways.
According to the IRS, crypto doesn’t qualify as a currency for tax calculation. Rather, it treats cryptocurrency as property, ruling that "the same tax principles that apply to property transactions apply to cryptocurrency trades."
The tax code doesn’t have any special sections or exemptions for Bitcoin or other virtual currencies: When you earn profits using cryptocurrency or accept cryptocurrency as payment, you will be taxed.
Remember that capital gains tax depends on what kind of gain you earned. Capital gains can be short-term or long-term depending on how long you own the asset, in this case, a cryptocurrency.
Profits and Losses from Short-Term Capital Gains
An asset's short-term capital appreciation or loss is accounted for when it's bought and sold within a year. You pay the same tax rate on short-term gains as on ordinary income, which includes your:
Note: According to the Internal Revenue Service (IRS), tax brackets for ordinary income ranged from 10% to 37% in 2021.
Long-term capital gains and losses
Investing in cryptocurrency for more than a year can yield significant returns when you sell it for more than you paid for it. Gains from these investments are taxed at more favorable rates, with percentages close to zero.
Buying cryptocurrency doesn’t trigger a taxable gain. All property is subject to this rule.
IRS considers buying digital assets like Bitcoin a net-neutral transaction. Cryptocurrency only becomes taxable in the following conditions.
In other words, increasing your wealth through work or selling assets other than investments results in taxable gains.
Cryptocurrency is taxed differently depending on whether you receive it as a form of payment or mine it for profit. Although the details might differ, you usually can't avoid paying taxes on crypto gains if you exchange them for profits.
Here’s the general rule:
The difference between what you made from selling a cryptocurrency and what you received in exchange for its calculated as your gain.
As you read in the section above, cryptocurrency is treated as income whenever you exchange it for products or services.
Remember that tax rates are applied differently for regular income and capital gains income — taxes on capital gains are generally lower than taxes on ordinary income.
It's important to remember that virtual currencies are still relatively new, and the IRS or Congress may (will definitely) change the rules on taxing virtual currencies in the future. You can’t just avoid crypto taxes, though.
Do note that fraud and evasion have severe consequences.
However, some strategies can help investors legally minimize their tax burden. Here are a few ways you can reduce or eliminate any potential taxes owed following the current cryptocurrency taxation rules.
Based on how long you own cryptocurrency, you will have to pay different capital tax rates. You can lessen your tax burden by waiting to liquidate your assets until they’re long-term assets.
In a nutshell, cap gains look like this:
Cryptocurrency gain (loss) = price at sale - price at the acquisition of cryptocurrency
A coin's acquisition value refers to its purchase price or how much you paid to own it. There is a difference between capital gains in the short-term (less than 12 months) and long-term (longer than 12 months).
The longer you hold your crypto, the lower your capital gains tax will be.
So investing in cryptocurrency long enough will lower your tax bill, as long-term gains will become short-term gains as you hold.
To avoid the crypto tax, you can invest in your crypto through:
A self-directed IRA allows you to invest in unique assets, such as:
Your first step should be to find a self-directed IRA that allows you to invest in cryptocurrencies. After you open and contribute to an IRA account, your tax benefits will vary according to your tax situation.
Traditional IRAs are another easy way to defer or eliminate taxes on cryptocurrency investments. They allow you to defer tax on gains made on cryptocurrency until you begin taking distributions.
Note: Traditional IRAs allow you to make tax-deductible contributions, but retirement withdrawals are subject to ordinary income taxes.
Here’s a short list of what tax-free thresholds look like in the UK, Germany, Australia, and the US.
Cryptocurrency gains are subject to US taxation, regardless of your location. It’s only Puerto Rico that is an exception to this rule.
Puerto Rico might be able to help you avoid some federal income taxes if you have substantial amounts of cryptocurrency holdings.
Puerto Rico-sourced profits from your online business will be taxed at only 4% if you qualify under Act 20.
The downside of this strategy is that it isn't as effective as it seems. Here’s the catch: the only way to file your taxes in Puerto Rico is to become a bona fide resident and maintain that residency.
There are many types of retirement accounts that you can invest in with cryptocurrency as an investment asset. Directly acquiring crypto tokens in a qualifying portfolio or investing in digital assets such as a cryptocurrency-indexed ETF is one way to accomplish this.
As with a traditional IRA, if you invest in a PP policy, keep it for some time — at least a few years — and eventually close it, tax-deferral benefits apply. Therefore, you’ll only have to pay the taxes on your gains when you close the policy.
The cryptocurrency will be tax-free if you keep the policy until your death and pass it on to your heirs — like a ROTH IRA. (If you want to ensure this inheritance is handled properly, consult a financial professional specializing in crypto and estate planning.)
Remember that cryptocurrency is still one of the most volatile asset classes in the world.
What does that imply?
It implies that crypto may be good for some parts of your portfolio since it can produce very real gains. But it can also be bad for other parts since it carries extremely high financial risk and has not shown any intrinsic value yet.
Whatever your capital gains are, your tax rate is determined by your overall annual earnings. In simple words, your tax rate will be lower if your taxable income is lower.
Selling cryptocurrency that will gain value in years could save you hundreds of dollars in taxes. By doing this, you'll pay taxes at a lower rate in the years to come.
That’s why many investors take profit on cryptocurrency gains during years of low income.
You may see a big difference in your tax bill by doing this in some circumstances, which brings us to:
In the same vein as selling high-value investments during a low-income year, lowering your taxable income is another tried-and-true tax minimization strategy. By studying the tax code, you can find deductions and credits that can reduce your taxable income.
Here are some ways you can save money on taxes:
A note on the last one:
You can indeed deduct your cryptocurrency donation from your taxes!
Donating at least some of the profits from your crypto investment to charity can lower your capital gains tax burden if you don't need all of the profits. If the charity is registered, you'll receive a deduction for the full value of your crypto, including capital gains.
The gift of cryptocurrency has its own tax benefits. You’re not liable for income tax if you give cryptocurrency as a gift. For gifts exceeding $15,000, a gift tax form is required, but it’s mostly for informational purposes.
There are also tax benefits for the beneficiaries: there is no tax liability associated with receiving a crypto gift.
Still, it's important for the gift recipient to keep an eye on the cryptocurrency's exchange rate at the time of acquiring it.
Why, you ask?
Because when the cryptocurrency is sold, these amounts are used to calculate any profit or loss that must be reported by the recipient.
It can be overwhelming to navigate the tax code by yourself. Consider hiring a professional if this is something you don't know what to do.
Investors often find that a quality accountant is worth the investment, even if it's a costly step. A cryptocurrency-savvy accountant can:
Lorenzo tax CPAs will simplify crypto tax liability for you. Schedule a call and let our professionals strategize and execute the best plan for you.
Crypto assets are either taxed as ordinary income or as capital gains. In other words, if you sell it and make a profit, you’ll normally have to pay taxes on those profits. Your tax liability can be reduced in a few ways, though, as with any investment asset.
Understanding how cryptocurrencies are taxed will enable you to minimize your crypto tax payments to the IRS. There are tax benefits to:
Over the next few years, there is bound to be an evolution in tax policy and financial regulation regarding cryptocurrency.
For your crypto taxes to be filed correctly and in compliance with the law, you should work with someone who knows the industry. Contact us today if you want to be updated about the latest market regulations, prices, and taxable events.
We offer our expertise for you to take advantage of legal loopholes and reduce your tax rate.