Cryptocurrencies are one of the hottest topics in financial news today. Statistics show that cryptocurrency investors made huge profits in the early stages of this technology, but recently the market has been volatile. Over the past few years, we've seen investors make profits, and we've seen some of those profits erode, from buying and selling virtual currencies.
You've probably already bought cryptocurrency yourself. If so, and if you haven't sold it yet, maybe you plan to keep it forever, or maybe you're just waiting for a better exit point. If the latter is your choice, then before you hit the “sell” button, you should think about how you will handle cryptocurrency taxes. That's right, if you sell it for a profit, Uncle Sam will surely want his share.
Of course, you want to minimize cryptocurrency taxes so you can keep more money and maximize profits. To do this, you must first have a basic understanding of how cryptocurrency income is taxed. Then you can start thinking about ways to lower or eliminate your tax bill. We hope the information and tips below will help you manage cryptocurrency taxes and help you get ahead financially.
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What is a crypto tax?
Cryptocurrencies are considered “property” for federal income tax purposes. For ordinary investors, the IRS considers it a capital asset. As a result, cryptocurrency taxes are no different than the taxes you pay on other gains from the sale or exchange of capital assets.
When you buy a capital asset, whether it's a stock, bond, house, widget, Dogecoin, Bitcoin, or other investment, you create a basis equal to its purchase cost. When you sell, you compare the results of the sales to determine whether you had a capital loss or a capital gain. If your income exceeds your basis, you have a capital gain. If it changes, you suffer a capital loss.
You should also consider the length of ownership of the asset. Depending on how long you hold the cryptocurrency, your profit or loss will be considered "short term" or "long term". This change will also play a big role in how much you pay in cryptocurrency taxes.
- Short-term capital gains and losses. When you buy and sell assets within 365 days, you recognize a short-term capital gain or loss. Short-term earnings are subject to the same tax rates you pay on ordinary income, such as wages, salaries, commissions and other earned income. The IRS has seven tax brackets for ordinary income, ranging from 10% to 37% in 2022.
- Long-term capital gains and losses. If you buy an asset and sell it a year later, the difference between the sale price and your basis is a long-term capital gain or loss. You will usually pay less tax on long-term gains than short-term gains because the rates are usually lower. Currently, there are three tax rates for long-term capital gains: 0%, 15% and 20%. The price you pay depends on your income.
How to Minimize Cryptocurrency Taxes
Now that you know more about cryptocurrency taxes, which are actually just another way of saying capital gains taxes, you need a number of strategies to minimize the amount you pay to the IRS. Here are some helpful tips to lower your tax bill.
1. Expect your short-term gains to turn into long-term gains
As we mentioned, different capital gains rates will apply depending on how long you hold your cryptocurrency. If you want to lower your tax bill, hold your cryptocurrency long enough to turn your short-term gains into long-term gains. It may not be an easy task, but if you have the patience and tenacity to hold your cryptocurrency for at least a year before selling it, you can probably pay lower taxes on any capital gains.
Here is an example. Mary, a single taxpayer, earned $70,000 in wages for 2022. He also had a capital gain of $5,000 from the sale of cryptocurrency, if the gain was a short-term gain, his ordinary income would be $75,000. After claiming the standard deduction, she had taxable income of $62,050, which put her in the 22% tax bracket and resulted in a tax bill of $9,268. However, if the gain is a long-term gain, $70,000 of ordinary income minus the standard deduction is still taxed at 22%, but $5,000 of capital gains is taxed at only 15%. That's a total of $8,918 in taxes and a savings of $350.
2. Offset capital gains against capital losses
Another strategy to reduce the taxes that cryptocurrency investors have to pay is to offset capital gains with capital losses. It works by deducting losses on crypto assets sold during the year from taxable gains on cryptocurrencies or other investments that appreciate in value.
But be careful. you face limitations when using this technique. When you recognize an investment loss, you must cover similar losses. For example, short-term losses will first reduce your short-term profits, while long-term losses will first reduce your long-term profits.
Then, if you have a net loss, you can use it to offset other types of equity. So, for example, if you have excess short-term losses, you can apply them to long-term capital gains.
If you still have net capital losses, you can use them to reduce your ordinary income. However, if you follow this strategy, you can only use up to $3,000 of capital losses to reduce your ordinary income in a given year. The remaining balance is carried over to the next year to offset future earnings or reduce your ordinary income up to $3,000.
3. Selling in a low income year
As you wait to shift your cryptocurrency gains from short-term to long-term, another timing factor you can consider is choosing to sell during low income years.
Short-term and long-term sales proceeds in low-income years can help with taxes. If you have short-term gains that are taxed as ordinary income, you won't have any additional income that pushes you into a higher tax bracket. For example, if you sell short-term assets in retirement and are no longer collecting a salary, your tax bracket may be based entirely on your short-term capital gains. If you have long-term capital gains, a lower level of total income for the year may also mean a lower tax rate on those gains. That's because the long-term capital gains rate that applies to you, whether it's 0%, 15% or 20%, depends on your taxable income. Therefore, if you have lower taxable income, you are likely to have a lower capital gains tax in the long run.
Also, if you decide to retire early and save enough money to cover your retirement account until you withdraw money from your retirement account, you may have little or no income during the year. If so, now is a good time to make long-term capital gains and potentially pay a 0% tax rate.
4. Lower your taxable income
Closely related to selling your valuable investments in low income years, another tried and true tax minimization strategy is to reduce your taxable income. This means searching the tax code for deductions and tax credits that can lower your taxable income.
For example, you can pay for expensive medical procedures, contribute to a traditional IRA or 401(k) plan, put money into a health savings account, or donate money or property to charity. There are many other deductions and tax credits you may qualify for as well. You can ask a tax professional to help you find other tax benefits.
5. Invest in cryptocurrency in a self-directed personal retirement account
Another strategy to reduce your cryptocurrency tax bill is to invest in a tax-deferred or tax-exempt Self-Directed Individual Retirement Account (SDIRA). That way, you can pay taxes later when you have less taxable income in retirement or earlier when you contribute to a Roth SDIRA because you expect higher taxes in retirement.
6. Give wealth to family members
Depending on the intended use of your assets, you may consider another option to reduce your cryptocurrency tax bill: donating cryptocurrency to your family members.
The IRS allows up to $16,000 per person to be paid each year without tax consequences. Although the basis of the cryptocurrency passes to the new owner, the recipient may receive income low enough that they will not pay taxes on the sale of the appreciated property. Or, at least, less tax than you would have to pay if you were to sell cryptocurrency.
These strategies certainly play into your larger estate planning goals and how you want to transfer your assets. This makes it something you should discuss with your estate planner first to make sure it fits with your overall plans.
7. Donate your valuable cryptocurrency to charity
Similar to donating valuable cryptocurrency to a family member, you can also consider donating your cryptocurrency to charity. Not only will this result in no capital gains tax, but it can also result in a significant tax deduction that you can claim on your tax return.
When you donate an asset, you can claim the estimated fair market value at the time of the donation as a deduction from your taxable income. For example, if you have $50,000 in Bitcoin and want to donate it to a charity you regularly support, you may be able to write off that amount as a charitable deduction on your return. Additionally, if a charity qualifies as a tax-exempt charity under section 501(c)(3), the charity is not required to pay capital gains taxes when it later sells the donated cryptocurrency.
8. Move to a country that has no income tax
In this article I forgot - until now - about the state income tax. Not surprisingly, your state may also be interested in your return on investment.
Fortunately, a number of tax-friendly states charge little or no income tax. This means you can pay taxes at the federal level, but you won't owe much to your state treasury.
If you can, consider moving to a low- or no-tax state to reduce or eliminate all types of income taxes. These savings can accumulate and help you save more cryptocurrency income.
9. Inherit your assets
The final strategy for minimizing cryptocurrency taxes on this list is to transfer your cryptocurrency assets as part of your estate. Upon your death, the investment will receive a "step up" (ie increase) based on the fair market value at the time of your death. That way, your heirs won't have to pay taxes on your loan principal when they sell their inherited cryptocurrency.
However, since cryptocurrencies have high volatility, depending on the virtual currency you own, it can go up (or down) at any time. if this happens and virtual currency virtual currency virtual currency चक आय, at least your successor has received an English token.