We all know how daunting it can be for the average crypto trader to report crypto taxes to the IRS. As a crypto trader, the last thing you wish for after reporting your taxes to the tax authority is to later find out that you omitted some important information that would have helped you reduce your tax bill.
There are strategies you can implement in a tax year that will help you minimize your tax exposure, and that’s what you will learn from this article. Ahead, you will learn the top three strategies that you can implement at tax time to minimize your crypto tax exposure.
Let’s get started.
The Top 3 Strategies To Minimize Tax Exposure
#1. Adopt Crypto Tax-loss Harvesting
One of the best ways to minimize your crypto tax exposure in the upcoming tax season is to use tax-loss harvesting. We all know how volatile the crypto market is. While the fluctuating nature of the market can cause anxiety among crypto traders and investors, implementing the tax-loss harvesting strategy can help you make profits during bear markets.
So what exactly is tax-loss harvesting?
It’s the practice of selling or disposing of your cryptocurrencies while the prices are still very low compared to their original prices when you first bought them, and then use the proceeds to offset your capital gains. If your capital losses for the year exceed your capital gains, you can use up to $3,000 of losses per year ($1,500 if you are married and filing separately) to offset regular income after reducing investment gains.
Additionally, this strategy lets you negate gains and/or offset up to $3,000 of ordinary income for the current tax year or future tax years. Effectively applying this strategy will not only help you sell off non-performing assets, your tax exposure will also be very minimal.
Selling cryptocurrencies for profits is a taxable event which attracts a capital gain/loss tax depending on how long you held the cryptocurrency in your wallet. According to the IRS, the tax rate payable by investors currently stands at 10-37% and 0-20% for both short-term and long-term holdings respectively. You may incur a heavy tax bill if you dispose of your cryptocurrencies.
But with the tax-loss harvesting strategy, you can dispose of your non-performing assets and then use the proceeds to offset your capital gains.
#2. Gift/Donate Crypto Assets To Qualifying Charity Organizations
One notion that every taxpayer has in common is knowing that disposing of their crypto assets for profits comes with capital gain taxes. However, do you know that gifting or donating your cryptocurrencies for charity purposes can help you minimize this tax exposure? Well, according to the IRS guidelines on tax returns, donating crypto assets to qualifying charity organizations doesn’t count as a taxable event.
This is a great strategy you can take advantage of. But make sure you donate your cryptocurrencies to an approved or qualified charity organization, otherwise, the tax authority may still come for you. The good thing about this strategy is that the IRS allows you to gift up to $16,000 per year per person without paying capital gains tax. The recipient might earn a low enough income where they won’t pay taxes on the appreciated property when sold. Or pay less taxes at the very least when they attempt to sell the assets.
The best way to donate your crypto assets to charity organizations is to donate only appreciable assets that you have held in your wallet for a long-term. This will help you deduct the fair market value (VMF) of your crypto assets. What about if you don’t have any appreciable assets? Then consider short-term crypto assets that have dropped in prices.
#3. Use The HIFO Accounting Method
This is another strategy that you can use to minimize your crypto tax exposure. Highest In First Out (HIFO) is a method of accounting for a firm’s inventories wherein the highest cost items are the first to be taken out of stock. This accounting method helps organizations decrease their taxable income since it will realize the highest cost of goods sold. However, nowadays, the HIFO accounting method is quite rare and no longer acceptable like GAAP or IFRS.
Capital gain/loss taxes are usually calculated using the prices you bought your crypto assets and the prices you later sold them. But do you know that specifying the particular cryptocurrencies you intend to sell can help you lower your capital gain/loss taxes and also minimize tax exposure?
According to the IRS’ tax guidelines, this is very possible. The IRS specifies two cost basis accounting methods for crypto assets: Specific Identification (SpecID) and FIFO (First in First Out).
The FIFO method is very simple to understand; it means selling off the cryptocurrencies you bought first. The problem with this accounting method is that you’re not at liberty to decide the crypto to sell, which is why the Specific Identification method is more superior.
Unlike FIFO, the Specific Identification method gives you the opportunity to specify which cryptocurrencies you wish to sell. This approach is great because it will help you minimize crypto tax liabilities.
For the Specific Identification method, you can adopt the Highest In First Out (HIFO) method to fully minimize your tax exposure. Companies prefer using the Highest In First Out (HIFO) method because it helps them decrease their taxable income for a period of time. Since the recorded inventory is usually the most expensive inventory on the company’s sheet, the company will always be recording the maximum cost of goods sold regardless of when the inventory was purchased.
The IRS doesn’t impose any cost-basis accounting method on taxpayers. You are at liberty to choose any method that is most suitable to you. However, the tax authority expects you to stick to a particular method in future tax reporting.
In summary, taxpayers can significantly decrease their crypto tax exposure by selling cryptocurrencies that are at a loss position to offset capital gains, gift or donate appreciable cryptocurrencies to qualifying charity organizations, and adopt the Highest In First Out (HIFO) method to determine their capital gains taxes.
These strategies provide effective ways to manage your tax liabilities, allowing you to maximize your savings and optimize your financial portfolio. Moreover, exploring alternative avenues to generate income, such as making money without the stock market, can further enhance your financial stability.
As the tax season approaches, utilizing a reputable tax calculator becomes crucial. By accurately reporting your crypto taxes through a reliable tax calculator, you can stay compliant with tax regulations, minimize your liabilities, and explore diverse opportunities to grow your wealth outside traditional investment avenues.