If you have started dabbling in crypto assets like Bitcoin, you might be on the hook for taxes. The good news is that you can take steps to lower your tax burden. Once you know how crypto is taxed, you can focus on strategies to minimize what you owe. Read on to learn more about tax-deferred crypto and retirement planning.
Cryptocurrency and Taxes
Unless you are investing in a crypto IRA, the IRS views cryptocurrency as a form of property, not currency. You’ll owe tax on gains you realize when you sell, trade or exchange crypto.
For example, you'll pay tax on gains if you sell crypto for more than you bought it for. If you use crypto to pay for services or exchange it for another cryptocurrency, you may also owe taxes.
How Much Tax Do I Pay on Crypto Gains?
How much tax you pay on crypto gains depends on your circumstances. Crypto traders can owe capital gains taxes.
How much money you’ve made for the year, your filing status and how long you’ve held the crypto affect how much tax you’ll pay.
When you sell crypto that you’ve held for more than one year, a gain you realize is taxed at long-term capital gains rates. Crypto long-term capital gains rates range from 0% to 20%, depending on your personal income and filing status.
On the other hand, short-term capital gains result when you sell crypto assets that you’ve owned for less than one year. The rates for short-term capital gains are the same as ordinary income and range from 10% to 37%, depending on your income and filing status.
However, investors don’t owe capital gains tax on crypto when held in a retirement account.
How to Reduce Crypto Taxes
Since the IRS views crypto assets as property, you may trigger a taxable event when you sell, exchange or spend crypto. The good news is that you can find ways to lower your crypto tax bill.
Reduce Your Taxable Income
If you drop your taxable income, you’ll pay less tax. Consider bumping up your 401(k) or IRA contributions or putting some money into a health savings account.
If you itemize your deductions, you might want to take care of a costly medical procedure you have been putting off. Or consider donating to charity if you have crypto that has appreciated after being held for more than one year. If you itemize, you can take a charitable deduction equal to its fair market value. Not only do you benefit from the charitable deduction, but you also avoid paying capital gains tax.
Hold Your Crypto Investments for the Long Term
Timing is everything. One crypto tax strategy you can follow is holding onto your crypto assets for at least a year before selling. If you can wait, you'll be taxed at the more favorable long-term capital gains tax rate.
Offset Capital Gains with Capital Losses
Another strategy to lower crypto taxes is to offset capital losses against capital gains. Consider selling investments that have decreased in value at a loss to offset your gains.
Remember that you must first offset gains and losses of the same class. So long-term losses first reduce long-term gains. Short-term losses reduce short-term gains. After that, any excess after that can be applied to the other class.
Move to a State With Lower or No Income Tax
In addition to the federal government, many states also want a cut of your crypto gains. If you can move to a tax-friendly state, such as Florida or Texas, you can hold onto more of your money. You can reduce crypto taxes by moving to a no- or low-income tax state.
Sell When You’re Earning Less
Many factors influence your tax rate, including your personal income. If you make less money than usual, you may be in a lower tax bracket. If you plan to go back to school or retirement is on the horizon, selling your crypto in a year when your income is lower can save you money. You may avoid paying capital gains tax if your income is low enough.
Invest Crypto in an IRA
Individual retirement accounts (IRAs) get preferential tax treatment from the IRS. You can reduce your tax liability when you make contributions to an IRA.
A crypto IRA is a self-directed account where you can invest in digital currencies. Most banks and financial institutions don’t support crypto assets, so you’ll need to find a custodian that offers crypto IRAs.
There are two main types of crypto IRA accounts. A traditional crypto IRA gives you the tax advantage of deducting contributions from your taxable income in the tax year you contribute - if you meet certain requirements. Once you reach retirement age, you pay tax on the funds you take out. With a traditional crypto IRA, you get the benefit of reducing your taxable income now. When you take distributions when you retire, you could pay less tax if you are in a lower tax bracket.
With a Roth crypto IRA, you won’t get a tax deduction when you contribute. However, you also won’t pay tax on your distributions when you reach retirement age. If you expect to be in a higher tax bracket when you retire, paying taxes now at a lower rate can save you money down the line. Regardless of which type of IRA you have, the IRS allows you to contribute up to $6,000 if you are under 50 or $7,000 if you are 50 or older in 2022.
How to Reduce Crypto Taxes
Even if you've been selling and trading crypto at a furious pace, you may be able to reduce your crypto taxes. With a little planning and strategy now, you can try to lower your tax bill at the end of the year. For long-term investors, a crypto retirement account can also offer tax advantages.
Frequently Asked Questions
Can you write off crypto losses?
You can offset your crypto losses against crypto gains. But if your crypto losses exceed your gains, you can deduct up to $3,000 as a capital loss in the current year. You can carry any amount over this limit to offset future capital gains.
Do I need to report crypto if I didn't sell?
If you didn’t sell the crypto you own during the year, you don’t need to report it. You only need to report to the IRS when you sell, trade or exchange crypto assets. Keep in mind that even though you may not have sold crypto assets, you may have to report transactions if you exchanged crypto for another virtual currency or used it to pay for services.
Can you defer crypto gains?
You can defer crypto gains by offsetting them against crypto losses. If you do not sell crypto until you have owned it for at least one year, you pay a lower tax rate when you sell.
What types of taxes will I pay on a crypto IRA?
Traditional crypto IRAs defer taxes, while Roth crypto IRAs could grow tax-free, depending on the assets you invest in. You could also save money by avoiding taxes on capital gains.