Famously, two things are certain: death and taxes. However, when it comes to the latter, there are valuable strategies you can take to reduce your tax bill. In what follows, we’ll outline five tips we commonly give traders about lowering their crypto taxes.
1. Tax loss harvest
Tax loss harvesting involves selling assets at a loss in order to offset your capital gains and thus lower your tax liability. TokenTax’s tax loss harvesting dashboard can be a valuable tool for this strategy, as it identifies which and how many assets you can sell off.
It’s important that you execute these trades before the end of the tax year; if you’re a U.S. tax payer, once January 1 rolls around, your capital gains and losses are locked in for the previous tax year.
Usually tax loss harvesting is used to offset capital gains, but you may want to do it even if you don’t have any crypto gains, as capital losses can also offset income or capital gains in other assets, such as traditional stocks.
2. Use HIFO/TokenTax minimization accounting
HIFO (highest in, first out) accounting, a form of the specific identification inventory valuation method, disposes of your tax lots with the highest cost bases first, thereby reducing that year’s tax liability. It works like this: Suppose you bought 10 ETH on Coinbase in 2019 when it cost $200. You leave the asset in your Coinbase wallet.
In 2021, you buy 2 ETH on 1inch when it is trading at $4,000 and keep the funds in your MetaMask wallet. A year later, you sell 2 ETH on Coinbase for $6,000 each.
If you were using HIFO accounting, you could assign the $4,000 cost basis of the ETH you bought in 2021 to the tax lots you sold in 2022 on Coinbase. By doing so, you reduce your capital gains from ($12,000-$400= $11,600) to ($12,000-$8,000=$4,000).
In TokenTax’s crypto tax software, we’ve built upon the HIFO method with our proprietary Minimization accounting method, which makes adjustments based on an individual’s tax rate to minimize crypto taxes as much as possible.
3. Donate crypto
Crypto donations to IRS-recognized non-profit or charitable organizations are not subject to capital gains taxes and in some cases are tax deductible.
If you purchased $20,000 of BTC and sold it more than a year later for $60,000, under normal circumstances you would have to pay long-term capital gains taxes on your $40,000 of profit. However, if you donate the asset, no capital gains taxes are owed—as long as the following criteria are met:
You have held the donated cryptocurrency for more than a year
You verify the intended receiver of the funds is considered a tax exempt organization by the IRS
You give the crypto directly to the organization without cashing it out or converting it to a different coin.. Both of these actions are taxable events.
Under many circumstances, your donation can also offset between 30 and 50% of your ordinary income, depending on the type of organization to which it was given and whether or not you are itemizing deductions.
4. Favor long-term capital gains
The IRS gives preferential tax treatment to investments held for more than a year. Long-term capital gains rates vary between income brackets but range from 0-20%.
Compare this to short-term capital gains tax rates, which are the same as your income bracket’s income tax rate (10%-37%).
The strategy is simple: hodling (for at least a year) pays off, at least in regards to your tax bill.
5. Don't sell
If all you ever do is buy crypto with fiat, you’ll never experience a taxable event.
The only way to be sure you won’t be taxed on your crypto is to simply hold it. But, if you do need to leverage your investments to pay your expenses, putting up collateral to borrow crypto is not a taxable event.
However, be aware that you may owe taxes on certain actions some protocols take with your collateral; for example Alchemix’s self-repaying loans can result in taxable debt cancellation income.
You will owe taxes if you experience a forced liquidation.
To stay up to date on the latest, follow TokenTax on Twitter @tokentax.