Introduction
Problem: Mastering the subtleties of being taxed with cryptocurrency could end up being a real headache. With the volatile values and ever-changing regulations, some crypto investors inevitably go in search of ways to legally avoid these taxes or reduce them as far as possible.
Platform: The IRS is the taxation authority in the United States. It naturally oversees the taxation of cryptocurrencies in the country. However, the tax rules imposed by this body are usually convoluted, and thus, most investors are out seeking practical and legally binding ways to handle their tax obligations.
Solution: In this video, we break down several legal ways to avoid or minimize the payment of cryptocurrency taxes. From holding strategies and tax benefits to more advanced financial tools, we explore the practical approaches that you can use to manage your crypto tax obligations effectively.
What Are Cryptocurrency Taxes?
Government considers cryptocurrency taxes, so do the U.S. Internal Revenue Service. Tax planning, therefore, requires very basic knowledge:
Understanding Capital Gains
In simple words, cryptocurrency taxation works the same way as is done with any other asset. Let’s consider a very simple switchover example to underscore the crux:
- Case: You buy Bitcoin for $1,000. Come the end of the year, its value has soared to $1,500.
- Tax Implication: Sell your Bitcoin now, and the profit—$500—is a capital gain, thus taxable.
It’s pretty much like any other asset: just the way the IRS taxes your profits from selling or exchanging cryptocurrency.
1. HODLing: The Easy Way Out
What is HODLing?
- Definition: HODLing, derived from a mis-spelt work “holding”, means holding onto your cryptocurrencies without selling.
- Benefit: By holding, you do not create a taxable event. No sale, therefore there would be no capital gains tax.
Considerations:
- Future Sales: If you change your mind about selling, you will still be liable to pay taxes on any price increment that was gleaned.
- Trading: Note, when you trade one cryptocurrency for another, that is a taxable event as well. For example, if you trade Bitcoin for Ethereum, that is a capital gain that is taxed at the time it occurs.
2. Long-Term vs. Short-Term Capital Gains
Breaking Down Capital Gains
- Short-Term Capital Gains: If you sell your crypto within one year of purchase, any gains resulting from that sale will be treated as ordinary income and will therefore be taxed at the regular income tax rates.
- Long-Term Capital Gains: Your gains are exposed to a lower tax rate in the situation where the cryptocurrency is held longer than one year. Fundamentally, the rates on long-term capital are more favorable, ranging between 0% to 20%, dependent on income.
Example:
- Short-Term: Because of the very high rates, it is very likely that selling Bitcoin after six months will attract a higher tax rate compared to when it is sold after more than a year.
Strategy:
- Hold Longer: Lower long-term capital gains rates mean that holding assets for over one year would benefit you when you sell.
3. Tax-Loss Harvesting
What Is It?
- Definition: Selling cryptocurrencies that have dropped in value with the purpose of balancing gains from other investments.
- Benefit: You realize losses that can be used to lower your total taxable gains for the year.
Example:
- Scenario: Suppose you bought Dogecoin for a hundred dollars. You later sold it for $70, which means you lost thirty dollars.
- Apply It: If you have made such a loss of $30 in any other cryptocurrency, for tax purposes, you could use it to reduce the overall amount you made and which is taxable.
Note: While this does lower your tax liability, there are better ways of dealing with it if doing so involves crystallizing losses of investments you have a lot of faith in over the long-term.
4. Move to a Crypto Tax Haven
Why Move?
- The Idea: Other jurisdictions have friendlier tax laws and reduced tax rates when it comes to gains on cryptocurrency. You could be relocating to enjoy such reduced rates, or, in some cases, give yourself an exemption.
Common Destination:
- Puerto Rico: Some Regional Centers of the U.S.A have massive tax relieves on crypto investors, including but not limited to, a statutory reduced tax rate on capital gains.
Considerations:
- Residency Requirements: Most jurisdictions require that you establish residency and live there for a majority part of the year.
- U.S. Tax Obligations: Even if you move abroad, the U.S. citizens are supposed to report their global income, but tax obligations may vary.
5. Setting Up a Crypto Roth IRA
Understanding Roth IRA
- Traditional IRA: Contributions are tax-deductible, but withdrawals are taxed.
- Roth IRA: All contributions are made with after-tax money, but the withdrawals are tax-free.
Crypto Roth IRA:
- Setup: Allows you to invest cryptocurrencies within a retirement account where all your investments will grow tax-free.
- Benefit: You will not be taxed on gains when you withdraw the funds during retirement.
Consideration:
- Eligibility: There are some customary income and contribution limits that are required to be held.
- Future Growth: Best suited if you think cryptocurrencies will be worth much more in the years to come, and you will find yourself in a bigger tax bracket in the future.
6. Loans to Avoid Immediate Taxes
How It Works:
- Concept: When you borrow money to go long in cryptocurrencies, you are able to avail and use those funds without selling cryptocurrencies—which would have been a taxable event—or liquidating your holding in the said cryptocurrency, so you can defer taxes until such time that those assets are sold.
- Tax Benefit: The borrowed funds are not considered taxable income.
Considerations:
- Risks: The approach carries risk, since you will be managing the loan repayment and interest. Ensure that the investment made is solid and the conditions of the loan are manageable.
Example:
- Scenario: You borrow a loan to buy Bitcoin. If you don’t sell the Bitcoin, then as long as you hold on to it, you avoid immediate taxes on any potential gains.
Conclusion
Navigating through cryptocurrency taxes should not be hard. One may tackle and possibly lessen their tax liabilities by the employment of the legal strategies of HODLing, rates of long-term capital gains, tax-loss harvesting, moving to jurisdictions with minimal taxes, crypto Roth IRAs, or even taking some loans.
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Disclaimer: This video is uploaded with the goal of educating viewers on cryptocurrency tax strategies and solutions and is by no means taken to be tax advice. Make sure that you contact a professional to modify strategies according to your personal financial situation.
