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Crypto: How To Lower Capital Gains on Cryptocurrency

Capital Gains on Cryptocurrency

Capital Gains on Cryptocurrency: The IRS first released guidance on the taxation of virtual currency in 2014, and has since updated its guidance as the virtual currency landscape has evolved. The most recent guidance, released in 2019, provides that virtual currency is treated as property for federal tax purposes.

As such, crypto trading on a crypto exchange is a taxable event and you may owe taxes (speak with a tax professional, as always).  This means investors are subject to capital gains tax on cryptocurrency.  The bottom line is that this means it will be time to pay taxes to the internal revenue service (IRS) on your next tax return if you have a gain on a crypto sale.

I’m sure you’ve heard of Bitcoin and other cryptocurrencies. It’s safe to assume that you even have invested in some yourself.  But you were also probably aware that you would owe capital gains tax if you sold your crypto.  If you didn’t before, you do by now.

Capital Gains on Cryptocurrency

What is capital gains tax? Capital gains tax is a tax on the profit you make when you sell an asset for more than you paid for it. So, if you buy a cryptocurrency for $100 and then sell it for $500, you would pay capital gains tax on $400.

The amount of tax you pay depends on a few factors, including your cost basis, the holding period that you held the asset and your gross income/ what tax bracket you’re in. But in general, you can expect to pay 15-20% capital gains tax on your profits.

Under the IRS guidance, any gain or loss from the sale or exchange of virtual currency is treated as a capital gain on cryptocurrency (or loss). This means that virtual currency is subject to capital gains tax. The tax rate on capital gains is generally lower than the tax rate on ordinary income, so this can be a significant benefit for taxpayers.  But it is important to understand, there is now capital gains on cryptocurrency. Why do I keep repeating myself – it’s to hammer the point home!

This affects all crypto currencies, including the most popular ones such as: Bitcoin (BTC), Ethereum (ETH), Tether (USDT), USD Coin (USDC), Binance Coin (BNB), Binance USD (BUSD), Cardano (ADA), Ripple XRP (XRP), Litecoin, NEO, and IOTA.

However, there are some important exceptions to the capital gains tax on crypo rule. 

Capital Gains Tax
Capital Gains Tax on Crypto

Crypto Short Term Capital Gains

First, if you hold virtual currency for less than a year before selling it, your gain or loss will be treated as short-term capital gain or loss, and will be taxed at your marginal tax rate. This is the same rate that applies to other short-term capital gains, such as gains from the sale of stocks or bonds.

Second, if you mine virtual currency, or receive it as payment for goods or services, you will be taxed on the fair market value of the virtual currency at the time you receive it. 

Crypto Long Term Capital Gains

Cryptocurrencies have been on a tear for years prior to 2022, with Bitcoin leading the pack. For those who have been lucky enough to be holding onto their crypto digital assets for the long term, the surge in prices has been a welcome windfall. And you are rewarded with the lower long term capital gains tax.

Declines of Crypto in 2022

If you have been holding cryptocurrency as a long or short-term investment, you may be wondering if you should sell now to take advantage of the lack of capital gains. However, there are a few things to consider before making a decision.

First, it is important to remember that the cryptocurrency market is still relatively new and volatile. This means that prices could continue to rise or they could just as easily drop further. If you sell now and prices continue to go up, you may miss out on substantial gains.

Second, taxes on capital gains can be quite high. For example, short-term capital gains are taxed at the same rate as regular income. This means that if you are in a high tax bracket, you could end up paying a significant amount of money to the government.

Finally, it is worth considering what you plan to do with the money you make from selling your cryptocurrency. If you are planning on reinvesting it into another cryptocurrency or using it to buy more Bitcoin, you may want to hold off on selling until the prices stabilize.

green exit sign for capital gains
Capital Gains Tax on Cryptocurrency

How To Avoid Capital Gains Tax on Cryptocurrency 

For more details on how capital gains work with your investments, see this article here:

What you might not know is that there are ways to avoid paying capital gains tax on cryptocurrency.  So, if you’re looking to cash in on your cryptocurrency gains, you may be wondering how to avoid paying capital gains tax. Here are a few strategies you can use.

6 ways you can lower or avoid capital gains taxes on your crypto

  1. Let’s start with an obvious answer, and that is to use the same strategy to avoid taxes as any other investment that you would own.  Buy crypto in your IRA.  Especially if you can buy crypto in your Roth IRA, and it could potentially be a large gain that will be tax free in the future!
  2. I know it is difficult for many to do – but try to hold onto your crypto for over 12 months.  If you do, it will now be taxed at the reduced long term capital gains rate instead of the higher short term capital gains rate.
  3. Will you have a lower income this year or next year, than usual?  If so, sell your crypto in the year that your income is lower than usual.  The lower that your income tax bracket is for the year, the better chance you will pay less, or even zero taxes on your crypto sale!
  4. Try to offset your crypto gains with losses when possible, to help reduce or eliminate your tax liability entirely.
  5. Hold onto your crypto forever, and never sell it.  When your heirs inherit the crypto, they will receive a ‘step up in basis’ – and the tax will all but be eliminated.
  6. Gift highly appreciated crypto to charity.  If you tend to be charitable – consider gifting the crypto that has grown in value instead of giving cash.  

If you hold your cryptocurrency for more than a year before selling it, you will be eligible for the long-term capital gains tax rate. This is typically much lower than the regular capital gains tax rate.  Even more preferable would be to hold onto your crypto within a Roth IRA so that it may one day grow and be withdrawn income tax free.  Lastly, consider leaving it to your heirs or to charity, to minimize the tax liability even further.

To learn more, read further here:

A Complete Guide to Federal Capital Gains Tax

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IRS: Frequently Asked Questions on Virtual Currency Transactions

Michael Ryan
Michael Ryanhttps://michaelryanmoney.com/
A former stockbroker, financial planner, and owner of my own financial planning practice and then a property & casualty agency. I have since retired and decided I want to help individuals and business owners by offering personal financial coaching. And now, I have started my blog - www.michaelryanmoney.com - to bring financial literacy to everyone. In a short time I have already been quoted and featured in US News & World Report, Business Insider, Yahoo Finance, and more (https://michaelryanmoney.com/home/press/) As a financial planner, I helped people from all walks of life. If you have questions about money, I will help you find the answers at www.MichaelRyanMoney.com
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