The Ultimate Guide to Reduce Taxes on Cryptocurrencies

how to save tax on cryptocurrency

Cryptocurrency continues to gain popularity across the globe. In fact, the number of people investing in these digital currencies keeps on increasing every year. It only shows that many people now fully understand the potentiality of Cryptocurrency to change their lives for the better and get interested in exploring new opportunities to earn and succeed. 

Moreover, if you’re one of them, you surely know how taxes work in this crypto world. Because of that, you may be thinking now about available options that will significantly help you minimize your crypto tax obligations. However, before you do that, you need first to understand how the IRS calculates your tax liability under crypto tax law in the country. By then, you can now look for effective ways to reduce your crypto taxes every year. Hence, read the complete information below to know about the US crypto taxation process and check the different strategies to give you tons of tax benefits. 

How Are Cryptocurrencies Taxed?

Cryptocurrency is taxable. The US tax law considers these digital currencies as property, like stock, for tax purposes. It means that you’ll be dealing with tax obligations in your Cryptocurrency asset, like what you do every year for other properties you own. This crypto taxation is under the IRS FAQ in 2014

Moreover, you’ll only owe Cryptocurrencies taxes when you sell your capital assets and gain a profit. It means that if you use your digital currency to pay for your purchases in the market, like products and services, and the crypto amount has increased in market value and become higher than what you initially paid for it when you bought it, that particular transaction has caused you to owe capital gain taxes. 

Let’s have a concrete example. You made a purchase ten months ago for a particular Cryptocurrency asset amounting to $50. Now, you’re still holding it, and you didn’t sell it yet. Then, over time, it had increased in value and became $500 from $50 when you bought it. So then, you decide today to use your capital asset of $500 to pay for your groceries with the same amount. 

It means that in this particular transaction, you now owe short term capital gains tax on the $450 income that you gain during the entire duration of holding your crypto asset. Besides that, the same thing will happen when you buy and sell your capital assets and other Cryptocurrency transactions that will make your existing assets increase in value.  

Furthermore, as mentioned earlier, you will only owe a short or long term capital gains tax when you do any crypto transaction that makes you gain a profit. On the other hand, if you bought a particular crypto asset for $200, but you were able to sell it for only $150 after eleven months, it means you’ve lost $50, and you didn’t receive any capital gain at all. It’s called a capital loss, and you didn’t owe any taxes for this particular crypto transaction. 

In fact, you can submit this incident when you file your return during tax season, and you may get an appropriate amount for your tax savings. Hence, these are the capital gains and losses that can happen to you whenever you make any transaction with your asset and even invest in a new one. 

NFTs and taxes are more complicated. We’ve written a tax guide for NFT creators and investors.

Always remember that the IRS will compute your crypto taxes based on the total income you’ve earned in the entire tax year and the holding period of your Cryptocurrencies. If you hold your capital asset for less than a year from the time you purchased it until someone bought it for a much higher value than the amount you paid for it when you bought it, it’s called short-term capital gains, and the tax rates for that are between ten to thirty-seven percent. You should also remember that mining cryptocurrency results in taxable income.

Can I Avoid Paying Taxes on Crypto?

Taxes are legal obligations of every taxpayer, including the nonresident and resident aliens in the country. However, when it comes to the profit you’re earning if you invest in Cryptocurrencies, you’ll surely notice a significant portion of it has been taken out to pay for your crypto tax bill. Keep in mind that failing to report your Crypto gains can result in an audit, or even a criminal tax investigation.

That’s why the effectiveness and the quality of the strategies you’ve employed when you invest in crypto to guarantee profits should always be the same as what you’ve utilized for your tax strategies to ensure you’re getting any tax benefits. Hence, after knowing how the IRS taxes Cryptocurrencies, you’re now ready to look for some available opportunities that can significantly help you reduce your crypto taxes. Therefore, check the details that follow for you to know how to save tax on Cryptocurrency.

You can also save money by using an LLC instead of Schedule C for crypto earned from mining.

Always Aim for Long-Term Gains

how to avoid taxes on cryptocurrency
Holding your crypto for at least a year can save you taxes.

As previously mentioned above, the longer you hold your Cryptocurrency asset while increasing its value, the more your tax obligations will decrease until it successfully gets sold or you use it to pay for any purchases. It’s because the particular tax rate to be applied in determining your total crypto taxes incurred will depend on the entire duration of holding a capital asset from the time you purchased it until you use or sell it. That’s why if you want to minimize your crypto tax liability during tax season, it’ll be so helpful if you always aim for long term capital gains instead of having any short-term gains that will give you much higher crypto taxes. 

Making Use of Your Capital Losses for Tax Benefits

Another effective strategy that any crypto investor has been using to reduce their Cryptocurrency taxes is to offset the capital gains you’ve earned with any of the capital losses that happened in some of your crypto transactions. It works by taking out the total value of your capital losses that have incurred during the current tax year from the summation of the taxable Cryptocurrency gains you’ve obtained. 

However, using this strategy may give you a particular limitation. It means that the long-term losses you’ve incurred should first offset your long term capital gains, and you can use the short-term losses to minimize your short-term gains. But, if you still have long-term losses that haven’t been applied yet because you have no long-term gains, you can use them to offset your short-term taxable gains. 

Moreover, if there are some capital losses that can’t be used because you haven’t earned any capital gains in the current tax year, you have an option to apply it to minimize your ordinary taxable income. But, the IRS will give you a limitation, allowing you to use a maximum of $3,000 of the capital asset you’ve lost to help you decrease your ordinary taxable income in the current tax year. 

Giving Asset to a Family Member as a Gift

Transferring your capital asset to one of your family members as a gift is totally tax free. In fact, the IRS permits taxpayers to give a particular capital asset as a gift to a chosen member of your family at a maximum of $15,000 in a year for one person. Some crypto investors use this strategy to help their family members who currently face financial challenges without worrying about getting taxed from this crypto transaction. 

Hence, if you plan to extend your help financially to a member of your family in the future, like your mom, dad, or one of your siblings, you can use this strategy, and there will be no extra Cryptocurrencies taxes that you need to add in your return from this specific transaction. 

Crypto Investments from States with Low or No Income Taxes

reduce crypto taxes
You can potentially reduce crypto taxes by moving to a different state.

Another smart strategy that will allow you to maximize your crypto profits and enjoy the tax benefits is making more crypto investments in different states in the US that offer a low tax rate and even no income taxes. You may be required to pay your tax bill at the federal level, but the state’s treasury will no longer require you to settle any tax obligations. Hence, these states are the best places where you can make a good crypto investment without worrying about your Cryptocurrency taxes increasing tremendously. 

FAQs

How can I avoid paying taxes on crypto?

Cryptocurrency taxes are a legal obligation of every crypto investor in the country. However, just like other taxes incurred from different properties you own, you can also use some lawful methods that will help you decrease your crypto tax obligations. It includes giving some of your crypto assets as a donation to a particular charity you’ve chosen. 

If the asset you want to donate is the one you’ve been holding for more than a year, you’ll receive a tax deduction of the same amount as the fair market value of your asset during the time of your donation. On top of that, you won’t pay for a particular capital gains tax when you donate assets. 

Another way to avoid Cryptocurrency taxes is through purchasing a crypto asset inside the 401-k, IRA, or other retirement plans. Doing so will defer your tax obligations incurred in your capital Cryptocurrency gains until you start taking your distributions. These are a few of those you can find out there to help you avoid or decrease your tax bill. But no matter what, always report your gains from cryptocurrency trading – otherwise you may be facing potential penalties, or even prison time.

Can Bitcoin help avoid taxes?

Bitcoin is a decentralized Cryptocurrency that many people are using for more opportunities to increase investments and double the profits. However, investing in it doesn’t give you an exemption from your tax obligations. That’s why you still have to report your Bitcoin transactions when you file your return during tax season. In addition, even though you’ll be paying the appropriate taxes on every profit you earn, there are still various ways you can, at least, lessen the amount of your tax liability. 

What are wash-sale rules?

If you have a taxable account, you can claim tax deductions when you sell your investment that failed or has lost money. However, some people only want to get the tax benefit and plan to buy another investment 30 days before and after the sale date, which is similar or “substantially identical” to the first one that has been sold. That’s why the IRS has included the wash-sale rules in their guidelines to prevent people from doing these activities. 

Hence, those who engage in this type of transaction will have their claim for a tax loss disallowed, and they’ll surely expect a tremendous increase in their final tax bill. Besides that, they can’t also use their capital loss to minimize their taxable income, and the holding period for the previous investment will be added to the new one you’ve just purchased. 

Can I start an offshore IRA LLC to avoid crypto taxes? 

The offshore IRAs merge the offshore account privacy and asset security while having access to Cryptocurrency. It’s a retirement account under your complete supervision and management. The exciting thing about it is that the account moves out of the US and will stay in a space where there’s zero tax at all. So if that is what you want, you can start creating an offshore digital IRA and bring your retirement account outside the country to enjoy its benefits and opportunities to maximize your crypto profits.

Moreover, the IRA can hold Cryptocurrency since the IRS defines it as capital assets. Hence, you’ll need to have a self-directed account if you want to keep your crypto asset within the US. But, you can also have an offshore IRA LLC if you wish to hold your crypto offshore without dealing with any tax obligations and will surely maximize your crypto profits. Besides that, it’ll also give you total control of your investment, and you’ll become the sole decision-maker on how you manage your account. It’ll also allow you to invest in precious metals, real estate, stocks, bonds, crypto, and many others. 

Can I sell crypto P2P to avoid taxes?

You can purchase Cryptocurrencies through P2P or Peer-to-Peer Exchange. It’s a particular platform using innovative software that allows people in the Cryptocurrency market to do trading directly with each other without the participation of any third-party individuals or entities. Besides that, it will enable you to browse to look for crypto sellers and find the best rate of your choosing, and there’s no need for any identity verification before you can start trading. 

The good thing about it is that it can only cause you less fee, either you sell or buy crypto using this platform, and it even provides you with various payment methods that you prefer. However, since the IRS considers crypto as property, like stock, investing or purchasing crypto will incur appropriate taxes that you need to report and include on your return when filing.  

How to buy crypto and avoid taxes?

If you want to buy Cryptocurrency assets and don’t want to pay taxes, one way to do that is to purchase crypto inside a retirement plan, like 401-k, IRA, and many others. Besides that, if you want to buy one inside the traditional IRA, you won’t also pay any taxes from the profits you’ll be earning until the time comes when you start taking your distributions. In addition, you won’t also pay for a particular capital gains tax when you buy crypto within the ROTH IRA. However, you’ll only be paying taxes on your regular contributions, but all of your withdrawal transactions in the future will always be tax free. 

Can I convert crypto to gold to avoid taxes?

Today, many investors want to buy precious metals, like gold or silver, because they want to make themselves ready whenever the possibility of failure in the market may happen in the future. Because of that, many jewelry stores or shops across the globe are now accepting digital currencies as payments in purchasing their products, including Ethereum, Ripple, Litecoin, Dash, Bitcoin, and many others. However, since you’re making a purchase using your Cryptocurrency, there will be a particular tax that you need to report in your return during tax season.

What to buy with crypto to save on taxes?

Technically, whatever crypto transaction you make that triggers a profit and even using it to make purchases will incur appropriate taxes. However, when you send your crypto as a gift to someone to buy goods and services may not cause you to pay taxes. But, it’ll still depend on the difference between your Cryptocurrency basis and the fair market value of the crypto on the purchase date. 

 Hence, always remember that any crypto transaction you make has a reporting tax obligation and tax implication. That’s why it’ll be best to take advantage of the Cryptocurrency accountants and the available tools to give you enough information before doing any transaction. 

How to avoid capital gains tax on Cryptocurrency?

Some investors, who want to avoid paying for capital gains taxes on Cryptocurrency, will usually purchase a crypto asset within an international life insurance policy. You can make the equivalent of a Traditional IRA or ROTH and pay for it in any amount you want for you to fund an Offshore Private Placement Life Insurance. The exciting thing about it is that there are no distribution qualifications or requirements, and there are no limitations to your contribution.  

In addition, another way to avoid capital gains taxes is to purchase Cryptocurrency assets as a resident of Puerto Rico. If you’re still young and you love to explore, travel, and look for more opportunities to increase your profits, you can consider moving to the Caribbean Island of Puerto Rico, which is a territory of the United States. It’s because the US Federal taxation doesn’t apply in Puerto Rico. That’s why Puerto Rico has the freedom to create its own tax laws. 

If you stay on the island for 183 days every year, purchase a house in two years, and meet the qualifications that Act 22 requires, you’ll then become a legal resident in Puerto Rico. Because of that, you’ll never pay taxes from whatever income you’ll be getting in your digital currencies, including the short and long term capital gains. It also means that you’ll be the sole owner of every cent of your income from making transactions and investments in Cryptocurrency. 

Conclusion

Investing in Cryptocurrencies offers tons of opportunities to many people across the globe. In fact, tons of lives have already been changed by every successful crypto transaction and having an informed decision to invest in this industry. However, one of the common problems that most investors face is to see their tax obligations continue to increase during tax season. Hence, since you already know how the IRS taxes Cryptocurrencies, it’s time for you now to explore some effective ways to decrease your owed taxes eventually. Check out our list of top crypto tax software.

You can start checking some of them, as discussed above, or you can begin searching online for more. Always remember that the effectiveness and quality of your profit-generating strategies should always be the same as your strategies in dealing with your taxes. Doing so will surely allow you to maximize your earnings and consequently minimize your Cryptocurrencies tax liability.

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