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2023 was an unprecedented year for crypto. It saw multiple crypto rallies, with the last one sending the total crypto market cap to a massive $1.42 trillion, a 2023 high. With the approval of Bitcoin ETFs, we could see cryptocurrencies soaring even more in 2024, so it could be a good time for investors interested in the lucrative crypto world to get into it.
Crypto could offer traders incredible profits, but a lot of them find themselves handing a significant portion of their profits to the IRS every year thanks to the capital gain taxes that every trader must now pay, with the IRS introducing new tax laws for Crypto Traders.
But the majority of traders either don’t know what the taxes are or how to file them optimally, which is why we’re going to explain how crypto is taxed in this video. We will also reveal five methods that any crypto investor can use in order to reduce their tax bill.
How do crypto taxes work?
Even though the point of crypto is to be a decentralized currency, the IRS doesn’t treat it as one, or, in the same way it treats cash. In fact, crypto is treated more as a commodity, similar to stocks.
This is because cash isn’t typically used for trading and making profits, unlike stocks and crypto. Of course, you could use cash to make profits by trading currencies, but then you’d get taxed on any gains you make. Similarly, the IRS introduced rules to tax crypto gains similarly to gains from stocks.
If you’re just holding onto your crypto and haven’t sold any, then you don’t need to worry about paying taxes on what you currently own. However, if you sell your crypto and make a profit or a loss, then you have to report it to the IRS.
If you sell your crypto and take a loss, then you shouldn’t have to pay taxes. In fact, the IRS allows you to deduct losses of up to $3,000 from your taxable income, and if you have lost more than $3,000, you can carry it forward to future years.
For example, if you made a loss of $7,000 in one year, and your income is $50,000, you can deduct $3,000 from the $50,000 and only have to pay taxes on $47,000. Then, you’d be left with $4,000 in losses that you can deduct from your taxable income over the next two years, $3,000 first, then the remaining $1,000.
That’s when you make a loss, but when you actually make a profit, this is when the real fun starts, at least for the IRS.
How do you report crypto taxes?
In order to be able to report your crypto gains or losses to the IRS, you need to keep track of your crypto transactions very well. Thankfully, this has become an easy process since most brokerage apps keep track of all your transactions for you, but if your brokerage app doesn’t do that for any reason, then it’d be useful for you to record everything yourself.
In general, the IRS considers a gain on any asset that was held for more than one year a long-term gain, and anything shorter than that is a short-term gain. This also applies to cryptocurrencies.
Short-term gains are taxed at the ordinary income tax rates, which differ thanks to multiple factors, such as your state, filing status, and annual income. As for the long-term gains, the tax rates for both the 2023 and 2024 tax years are 0%, 15%, or 20%, depending on your income.
Once you’ve calculated your gains and losses and determined whether they were short or long-term capital gains, you’re ready to fill out the required tax forms.
If you’re reporting both short and long-term gains and losses, fill out tax Form 8949, which is used to report sales and exchanges of capital assets. After that, you should also fill out and file a regular income tax form, Form 1040, which includes a space to summarize your transactions from Form 8949. Then, your work would be done.
5 Methods to Reduce Crypto Taxes
Take a loan
For the first method you can use, you could take out a loan against your cryptocurrencies. This only works if you haven’t sold any crypto yet.
You can go to platforms like Aave, Compound Finance, or Nexo, who can give you a loan against a crypto portfolio as collateral. This will help you avoid paying taxes on your cryptocurrencies, as loans are considered non-taxable by the IRS.
Remember, you’ll still have to pay the monthly payments for the loan and also the interest, but this doesn’t mean that you’ll be losing money. You could be smart with the loan you receive, and use that money to invest in stocks that could give you returns higher than the payments you’d have to make.
There are a lot of upsides to this method, as you’d avoid paying taxes on your cryptocurrencies, still keep your assets, and you can reinvest the loan money. However, it might not be the perfect method for you if you’re uncomfortable with having to pay back the loan.
Invest through a retirement account
For the second method, you could make your crypto transactions under a tax-deferred retirement account.
If you buy or sell crypto under a tax-deferred retirement account, such as a traditional IRA account or a 401k plan your work might provide, then you could save a lot of money on your taxes. This is because the IRS allows you to deduct the contributions you make to your retirement account from your income. For example, if your income is $50,000 a year and you contribute $3,000 to your IRA account, you could deduct this contribution and only have to pay taxes on $47,000 out of your $50,000 income.
If you buy and sell cryptocurrencies through a retirement account, you could build wealth using crypto while minimizing your taxes at the same time. However, many well-known IRA providers might not give investors the opportunity to invest in cryptocurrency directly, so you can invest in cryptocurrency through a self-directed IRA.
Self-directed IRAs allow investors to store their savings for retirement in alternative investments such as real estate, precious metals, and cryptocurrencies. There are several options available for self-directed IRAs that allow investors to invest in cryptocurrencies, such as iTrustCapital, Bitcoin IRA, and Coin IRA.
If you are under the age of 50, you are allowed to contribute up to $8,000 a year in total to all of your IRAs, including self-directed IRAs.
The downside to this method, however, is that you still have to pay the taxes once you retire and actually withdraw the money, so think of it as a double-edged sword. The age you’re allowed to start withdrawing your money from retirement accounts is 59 and a half, but you can withdraw before that and pay a fee.
For the third method, which is a really popular method anyone can use to avoid or reduce their taxes, we have charitable donations.
A charitable donation is a gift to a tax-exempt non-profit organization, which can reduce your taxable income. In order to make use of this, you must donate to an IRS-recognized charity and receive nothing in return for your gift. Of course, this gift can be in cryptocurrencies, depending on the organization you plan on donating to. Some examples of tax-deductible non-profits that accept crypto donations include the American Cancer Society and Save the Children U.S..
It’s important to make sure that the organization you plan on donating to is IRS-recognized since some donations don’t count as tax deductions. But, don’t worry, this isn’t a hard process at all. In fact, you can verify an organization’s status with the IRS Exempt Organizations Select Check tool.
After donating, it’s important to keep track of your donations no matter how small, since you’d need documents to prove your donation in order to get a tax deduction. Finally, you have to keep the deadlines in mind. For your donation to be considered tax-deductible when you file, it must have been made by the end of that corresponding tax year.
For example, you have until Dec. 31, 2024, to make donations you want to claim on your 2024 tax return, which gets filed by April 2025.
This is a really good method to save taxes on your income if you make a lot of gains from crypto, as donating cryptocurrency is one of the few occasions when disposing of cryptocurrency is not taxed.
Sell during low-income periods
As for the fourth method which can help you reduce the taxes on your crypto gains, we recommend selling your cryptocurrencies during low-income periods.
This method is quite a forward way to minimize your tax burden overall, and it works because your tax liabilities are determined because of how much money you make. The lower your income, the lower the taxes you have to pay.
By taking this approach, investors may fall into a lower tax bracket and therefore benefit from a lower tax rate, so investors might want to “cash in” on their crypto investments during times in their lives when their income has dropped.
For example, if an investor who has crypto holdings and has been laid off, their income level will naturally be lower, presenting an excellent opportunity to sell their crypto. However, this also must be balanced by the fact that overall income will be less than usual. Therefore, if you’re expecting to make less money for whatever reason, then it could be a good opportunity for you to sell your crypto holdings during that period.
Invest for the long-term
For the fifth and final method you could use to reduce your crypto taxes, you could just hold your crypto for longer in order to achieve long-term capital gains when you eventually sell it.
As mentioned above, short-term capital gains and long-term capital gains are taxed differently. For the short-term capital gains, you get taxed based tax rates that range from 10% to 37%, depending on your income.
On the other hand, you’ll greatly benefit from your patience if you hold your crypto investment for one year or longer in order to record a long-term capital gain; since the American tax code is set up to encourage long-term investment, the capital gains tax on your profits will be significantly lower.
Long-term capital gains are taxed at 0% to 20%, depending on your income and filing status. For example, if your taxable income is less than or equal to $41,675 and you’re filing taxes as a single person or if you’re married but filing separately from your spouse, your long-term capital gains could be taxed at 0%!
Another way you can benefit from this is if your income is $83,350 and you’re married and filing for taxes jointly with your spouse, then some or all of your net capital gain could also be taxed at 0%.
Remember, it’s important to check the IRS website to know if you qualify for these tax benefits.
The Bottom Line
To sum up, if you’re a profitable crypto trader, then you must pay crypto taxes on your gains. However, that doesn’t mean you can’t reduce the taxes you have to pay in a few different ways.
You can take advantage of the IRS system of deductions to lessen your tax burden. You’d actually be surprised to know that just a few hours on the IRS’ website each year can save you thousands of dollars.
Always research tax regulations well, especially if you’re in a state with special tax regulations, and use the help of a tax professional if you need it or a platform that could help you do your crypto taxes, such as Koinly, CoinLedger, and TokenTax, who offer free trials and services that start at the low price of $45 per year.
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