Cryptocurrency’s rise in popularity has caught the attention of investors worldwide. However, along with the excitement and potential for profit, you must also consider your tax obligations. Tax authorities, like the IRS, are paying closer attention to virtual currencies, making it crucial for crypto investors to fulfill their tax responsibilities accurately. Luckily, there are strategies available to help you minimize your tax liability while staying on the right side of the law. These methods are designed to ensure that you pay less in taxes and keep more of your earnings. It’s important to remember that these strategies should be used responsibly and ethically, adhering to existing tax regulations. In this guide, we will show you how to legally reduce crypto tax payments specifically in 2024.
How to Legally Reduce Crypto Tax Payments
You are required to pay taxes legally, and you cannot completely avoid this responsibility. If you try to evade taxes, especially in relation to cryptocurrency, you will face severe penalties. However, there are straightforward actions you can take right now to lower the amount of taxes you owe before the end of the financial year. These steps can help legally reduce crypto tax payments bill:
1. Keep a record of your profits and losses
If you’ve had a successful year in terms of making profits, you need to be prepared for the tax obligations that come with it. Surprisingly, many investors fail to track their gains or losses throughout the financial year, which can make it difficult to stay on top of their tax responsibilities.
To simplify this process, you can use tools like Koinly, which act as both a tax calculator and portfolio tracker. Once you set it up, you’ll have a convenient overview of all your realized gains and losses right from your dashboard. This way, you’ll always have a clear understanding of the tax liability associated with your crypto investments.
In addition, it’s important to monitor your unrealized losses on a larger scale as well as for specific investments. This is significant because you can strategically utilize these losses to lower your tax bill in a thoughtful manner.
2. Take advantage of potential losses that haven’t been realized yet
Losses in the world of investing can be categorized into two types:
- Realized Loss: A realized loss occurs when you sell, swap, or spend an asset for a price lower than what you originally acquired it for.
- Unrealized Loss: An unrealized loss refers to an asset that has decreased in value since you obtained it, but you still hold onto it without selling or disposing of it.
For instance, if you bought BTC for $20,000, and its current value is $16,000, but you haven’t sold it yet, you have an unrealized loss. You will only realize the loss when you decide to sell, swap, or spend your BTC.
Understanding the distinction between realized and unrealized losses is crucial because you can utilize these losses to potentially lower your tax obligation. Once you realize these losses by taking action, you can offset them against your gains, resulting in a reduced overall tax liability.
Losses can actually be helpful when it comes to paying taxes. If you have investments that have decreased in value but you haven’t sold them yet, those are called unrealized losses. You can use these unrealized losses to legally reduce crypto tax payments you owe.
To do this, you need to “realize” the losses by selling or swapping the investments at the lower value. By doing this, you create a taxable event, and you can deduct those losses from any gains you’ve made.
For example, let’s say you made $1,000 in gains from selling one cryptocurrency, but you have another cryptocurrency that has lost $500 in value. By selling the losing cryptocurrency and realizing the $500 loss, you can subtract that loss from your $1,000 gain. This means you will only be taxed on the remaining $500 gain instead of the full $1,000.
By using this strategy, you can lower your taxable income and, as a result, pay less in taxes on your cryptocurrency investments.
Remember, it’s important to consult with a tax professional who can guide you through the specific rules and regulations in your area. They can help you understand how to optimize your tax situation and make sure you’re following the law while minimizing your tax liability.
3. Balance out your gains by using losses
|When Gain is More than Loss
|Use losses to offset gains
|If you made $10,000 from selling one cryptocurrency but had $5,000 in losses from another investment, you would pay taxes on $5,000 profit
|When Gain Equals Loss
|No taxes owed when losses equal or exceed gains
|If you made $15,000 from one cryptocurrency but had $15,000 in losses from another investment, no taxable income and no taxes owed
|When Gain is Less than Loss
|Deducting extra losses from overall income
|If your losses exceed your gains, you can deduct up to $3,000 ($1,500 if married and filing separately) or the total amount of losses
Using losses to balance out your gains can help you reduce the amount of taxes you have to pay in a few ways Here are three different scenarios:
- When Gain is More than Loss: When you make money from selling cryptocurrencies, you can use losses from selling other investments to reduce the amount of taxable income from your gains. For example, if you made $10,000 from selling one cryptocurrency but lost $5,000 from selling another investment, you would only pay taxes on the $5,000 profit instead of the full $10,000.
- When Gain Equals Loss: If your losses are equal to or more than your gains, you won’t owe any taxes. So, if you made $15,000 from one cryptocurrency but lost $15,000 from another investment, you won’t have any taxable income, and you won’t owe any taxes on your crypto transactions.
- When Gain is Less than Loss: If your losses are more than your gains, you can deduct the extra losses from your overall income. You can deduct up to $3,000 ($1,500 if married and filing taxes separately) or the total amount of your losses, whichever is less. This deduction reduces your overall taxable income, which means you’ll owe less in taxes.
By using losses to balance out gains and potentially deducting losses from your income, you can lower the amount of taxes you have to pay on your cryptocurrency transactions. It’s a good idea to talk to a tax professional who can help you understand the specific rules that apply to your situation and make sure you’re following the tax laws correctly.
4. Choose the most suitable way to calculate the cost of your assets
Choosing the most suitable way to calculate the cost of your crypto assets can indeed help lower your crypto tax liability. Here’s how:
- FIFO (First In, First Out): This method assumes that the first cryptocurrency you acquired is the first one you sell or exchange. By using FIFO, you are likely to have a higher cost basis for your assets, which can result in lower taxable gains. This method is generally considered the default and widely accepted by tax authorities.
- Specific Identification: This method allows you to choose which specific assets you are selling when calculating gains or losses. It can be beneficial if you have a particular strategy to minimize your tax liability. For example, if you acquired certain cryptocurrencies at a higher cost basis and others at a lower cost basis, you can select to sell the assets with the higher cost basis to reduce your taxable gains.
- Average Cost Basis: This method calculates the cost basis by averaging the cost of all your cryptocurrency purchases. This can simplify the calculation process, especially if you make frequent purchases. However, it may not provide the same level of tax optimization as FIFO or specific identification.
It’s important to note that tax regulations and requirements vary by jurisdiction. Therefore, it’s crucial to consult with a qualified tax professional or accountant who is knowledgeable about cryptocurrency tax laws in your specific country or region. They can provide guidance on the most suitable method for calculating your cost basis and help you comply with tax regulations while minimizing your tax liability.
By carefully selecting the appropriate method for calculating the cost of your crypto assets, you can potentially reduce your taxable gains and lower your overall crypto tax burden.
5. Get a crypto loan
Getting a crypto loan does not directly lower your crypto tax liability. However, it can provide certain advantages that may help manage your tax obligations more efficiently. Here’s how:
- Avoiding Taxable Events: When you obtain a crypto loan, you are essentially borrowing against your cryptocurrency holdings without triggering a taxable event. This means you don’t have to sell your crypto assets, which could potentially generate taxable gains or losses. By keeping your assets intact, you can defer tax obligations until a later date when you decide to sell or dispose of the assets.
- Cash Flow Management: Crypto loans can provide you with immediate access to cash without liquidating your crypto holdings. This liquidity can be useful for various purposes, such as covering expenses, making investments, or managing financial emergencies. By leveraging your crypto assets through a loan, you can maintain your investment positions while meeting your financial needs.
- Tax Deductibility of Interest: In certain jurisdictions, the interest paid on a crypto loan may be tax-deductible. This means that the interest expense incurred on the loan can be deducted from your taxable income, potentially reducing your overall tax liability. However, the deductibility of interest expenses can vary depending on local tax laws, so it’s essential to consult with a tax professional familiar with cryptocurrency regulations in your jurisdiction.
While crypto loans can offer benefits in terms of cash flow management and deferring taxable events, it’s important to note that they introduce additional financial considerations. Borrowers typically incur interest charges and may need to repay the loan according to the agreed-upon terms. It’s crucial to evaluate the terms and risks associated with crypto loans, such as interest rates, collateral requirements, and potential market fluctuations, before deciding to pursue such financing.
As always, it’s advisable to consult with a qualified tax professional or accountant who can provide personalized advice based on your specific circumstances and the tax regulations applicable to your jurisdiction. They can help you understand the potential implications of obtaining a crypto loan and guide you in managing your tax obligations effectively.
6. Use tax free thresholds & deductions
To legally reduce crypto tax payments on your cryptocurrency earnings, there are a few things you can do. The government offers certain deductions and credits that can help lower your overall tax bill. It’s important to understand these options and take advantage of them.
One option is to use the standard tax deduction. This is a set amount of money that you can subtract from your income before calculating your taxes. The specific amount depends on your filing status (such as single, married, or head of household). If your income is below a certain threshold, you won’t have to pay income tax on that portion of your earnings.
The standard tax deduction is usually easier and faster to use. However, there are other deductions you can consider if you qualify for them. These deductions allow you to subtract specific expenses from your income, reducing your taxable income even further.
Some common deductions include:
- student loan interest,
- education credits,
- child tax credits,
- medical expenses,
- mortgage interest,
- contributions to retirement accounts,
- and contributions to health savings accounts.
If you have multiple deductions that apply to your situation, it may be more beneficial to itemize your deductions instead of taking the standard deduction. Itemizing means listing out each deduction separately on your tax return. This can be more time-consuming, but it might result in greater tax savings.
It’s worth mentioning that there are additional deductions available for self-employed individuals and small business owners.
In addition to deductions, there are also certain income thresholds for capital gains tax. If your income falls below these thresholds, you won’t have to pay capital gains tax on your cryptocurrency gains. The thresholds vary depending on your filing status.
It’s important to note that tax laws can be complex, especially when it comes to cryptocurrencies. It’s highly recommended to seek advice from a tax professional or accountant who can guide you through the process and help you make the most of the available deductions and allowances based on your specific circumstances.
Remember to review your personal situation and consult with a professional for accurate and personalized advice regarding your crypto taxes.
7. Giving and donating cryptocurrency
Giving and donating cryptocurrency can help lower your tax payment in the following ways:
- Gifting Crypto:
- When you give cryptocurrency as a gift to someone, you can take advantage of the gift tax exclusion. In the United States, you can give up to $17,000 (for 2023) to each person without having to pay any gift taxes. This means you can reduce your taxable income by the amount of the gift. By gifting cryptocurrency, you can get rid of it without owing taxes on any capital gains.
- Donating Crypto:
- If you donate cryptocurrency to a registered charitable organization, you can receive tax benefits. When you donate crypto, you can deduct the full value of the cryptocurrency, including any capital gains, from your taxable income. This deduction lowers the amount of income that is subject to taxation, reducing your overall tax bill.
It’s important to note that the charitable organization must be registered as a 501(c)(3) organization in the United States. You can check their status on the IRS’ exempt organization database.
To make the most of these tax benefits, remember to keep proper records of your gifts and donations. Depending on the amount, you may need to report them on specific tax forms and provide documentation, such as receipts from the charity. Additionally, for larger donations valued over $5,000, you may need an appraisal from an independent party.
By gifting and donating cryptocurrency, you not only have the satisfaction of helping others but also the opportunity to lower your tax payment by reducing your taxable income. It’s always a good idea to consult with a tax professional for personalized advice based on your specific situation.
8. Investing in an IRA (Individual Retirement Account)
Investing in an IRA (Individual Retirement Account) is a smart way to optimize your taxes and save for retirement. An IRA is a special type of account that you can use to invest in things like retirement funds, pensions, or annuities. When you invest in a Bitcoin IRA, for example, you can enjoy some great tax benefits.
There are two main types of IRAs:
- Traditional IRA
- Roth IRA
With a traditional IRA, the money you contribute is tax-deductible up to a certain limit. This means you can lower your tax bill by deducting the amount you contribute to your IRA. Plus, you won’t have to pay taxes on your investment gains until you withdraw the money during retirement when you’re likely to be in a lower tax bracket.
On the other hand, with a Roth IRA, the money you contribute isn’t tax-deductible. However, the big advantage is that you won’t have to pay any taxes on your investment gains when you withdraw the money in the future.
By investing in an IRA, you’re effectively planning for your retirement while enjoying tax advantages. It’s always a good idea to explore different IRA options and consult with a financial advisor to determine the best approach for your individual circumstances.
9. Hold the investments for a long time
If you have enough time, it can be a good strategy to wait for a lower tax rate before taking profits.
If you can afford to wait, you can choose to hold onto your investments for a longer period. By doing so, you might be able to take advantage of a lower tax rate in the future. This could be beneficial if you plan to hold the investments for a long time, change jobs, or if you know you’ll be moving to a state with lower income taxes.
10. Using Crypto tax software
Using crypto tax software can help you lower your crypto taxes by providing accurate calculations, organizing your transactions, and identifying potential deductions and tax strategies.
Here’s how crypto tax software can be beneficial:
- Accurate Calculations: Crypto tax software automates the process of calculating your taxable gains and losses, which can be complex and time-consuming to do manually. By accurately calculating your tax liability, you can ensure that you’re not overpaying taxes.
- Transaction Organization: Crypto tax software can import and organize your transaction data from exchanges and wallets, making it easier to track and categorize your crypto activities. This saves you time and reduces the chances of errors or omissions in your tax reporting.
- Tax Optimization: Advanced crypto tax software often includes features that help optimize your tax liability. It can identify tax-loss harvesting opportunities, where you strategically sell investments at a loss to offset gains and legally reduce crypto tax payments liability. Additionally, the software may suggest specific accounting methods (FIFO, LIFO, etc.) that can minimize your tax burden.
- Reporting and Documentation: Crypto tax software generates comprehensive reports and tax forms, such as Form 8949 and Schedule D, which are necessary for accurate tax filing. These reports help ensure compliance with tax regulations and provide the documentation you need in case of an audit.
However, it’s important to note that while crypto tax software can assist in optimizing your tax situation, it does not guarantee tax savings or replace the need for understanding tax rules and consulting with a tax professional. Tax laws can be complex and subject to change, so it’s always wise to seek professional advice tailored to your specific circumstances.
We hope this complete guide has given you a better understanding of how to Legally Reduce Crypto Tax Payments. If you have any more questions or need help with buying or trading cryptocurrency, please feel free to leave a comment. Your feedback is important to us as it helps us improve our future articles. Also, don’t forget to subscribe to our daily newsletter to stay updated on the latest news and updates about cryptocurrency, NFTs, the metaverse, and AirDrops.