Although it’s not the most interesting aspect of investing in cryptocurrencies, you must understand how taxes on them operate if you choose to do so. Even though cryptocurrencies are still in their infancy, the IRS is making great efforts to enforce crypto tax compliance.
You might owe taxes on cryptocurrencies in several different ways, and even exchanging one Cryptocurrency for another is a taxable event. It may be challenging to piece together your gains and losses at tax time if you don’t maintain reliable records. Furthermore, even if it was an honest error, you risk incurring exorbitant fines if you fail to pay your cryptocurrency taxes.
Maybe you’ve already purchased some cryptocurrency. If this is the case, and if you haven’t already sold, you might be aiming to hold forever; alternatively, likely, you’re simply looking for a better exit strategy. If the latter, you should consider your strategy for handling cryptocurrency taxes before pressing the “sell” button.
Cryptocurrencies are not considered to be currencies by the IRS but rather a sort of property. You must pay taxes on Bitcoin’s current value if you accept it as payment. You must pay taxes on the difference between the price you paid for the Cryptocurrency and the sale’s revenues if you sell it for a profit.
You must also take into account how long you have owned the asset. Your gains or losses in cryptocurrencies will be classified as “short-term” or “long-term,” depending on how long you hold them. This distinction will also significantly impact the amount of cryptocurrency taxes you must pay.
How do you report Crypto Taxes?
Despite the recent modifications to cryptocurrency tax laws, it is still largely the individual’s responsibility to keep track of their earnings and losses. Remember that the IRS now includes a question on tax return forms asking taxpayers if they received, sold, swapped, or disposed of “any financial interest in any virtual currency.
Keep thorough records to ensure that you adhere to the regulations. You must keep track of your Cryptocurrency’s fair market worth both when you acquired or mined it and when you used or sold it. You can use that data to compute your cryptocurrency taxes.
If you make more than $20,000 in payments and 200 transactions each year, a Form 1099-K may be sent. However, both requirements must be fulfilled, and many individuals might not use Bitcoin or other cryptocurrencies 200 times a year. But regardless of whether you go above these limits, you still have to pay taxes on any gains.
How to Minimize Crypto Taxes
1.Hold off until your immediate gains become long-term gains.
As mentioned, depending on how long you own bitcoin, different capital gains rates will be applicable. Hold your cryptocurrencies long enough to convert your short-term gains into long-term gains if you want to reduce your tax burden. Although it may not be simple, if you can maintain your Cryptocurrency for at least a year before selling it, you’ll probably pay a lower tax rate on any capital gains.
2.Capital Gains and Capital Losses Should Be Offset
By offsetting capital gains with capital losses, crypto investors can reduce their tax burden. This works by deducting taxable gains on cryptocurrencies or other investments that have increased in value from losses on crypto assets you sold throughout the year.
3.Sell in a year with Low Income.
You might also think about another timing factor when waiting for your cryptocurrency gains to transition from short- to long-term: picking a low-income year to sell in.
4.Reduce Your Taxable Income
Another tried-and-true method of tax minimization is reducing your taxable income, which is closely tied to selling your appreciated investments in a year of low income. To do this, search the tax code for tax credits and deductions that can reduce your taxable income.
5.Invest in Crypto in a Self-Directed Individual Retirement Account
Investing in a tax-deferred or tax-free Self-Directed Individual Retirement Account is another way to reduce your crypto tax liability (SDIRA). In this approach, you can choose between paying taxes upfront when you contribute to your Roth SDIRA because you anticipate paying more in taxes in retirement or later when you might have a lower taxable income in retirement.
Because of the high volatility associated with cryptocurrencies, the value of the virtual currencies you own could suddenly increase or decrease. At least your heirs’ tax burden won’t be as high if this occurs and virtual currencies take off because they were given the tokens on a stepped-up basis.