The Halving (sometimes referred to as “the Halvening”) is the predetermined moment when Bitcoin’s block subsidy gets cut in half. The halving of Bitcoin’s block subsidy occurs every 210,000 blocks (approximately every four years) and is a key feature of Bitcoin.
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W2s and 1099s have been sent out and tax season is officially in full swing here in the United States. For those operating in the world of Bitcoin or altcoin investing, this time of year can have added stress as reporting gains and losses for your crypto trades can be a cumbersome task. While the reporting can be difficult at times, there are many things you can do to help minimize your Bitcoin and other cryptocurrency gains and, in turn, your tax liability. This article discusses a few of these tips and tricks.
Open a Crypto 401(k) or IRA Retirement Account
Retirement accounts like IRAs and 401(k)s are popular vehicles used in the world of investing. These types of investment accounts come with tax incentives and can help shield profits from the tax man. By using a retirement account like a self-directed IRA to purchase cryptocurrencies, you can defer paying tax (sometimes you can even pay none at all).
This is contrary to using a traditional cryptocurrency exchange where the income generated from selling or trading crypto is taxed during that same year. Cryptocurrency IRAs can be an effective tax reduction tool — especially if you believe in the long-term value of cryptocurrencies.
Keep in mind that there is a deadline to open and contribute to your self-directed cryptocurrency IRA. The period in which you can make a contribution for a given tax year is from January 1 of that year until you file your tax return. Contributions cannot be made after your filing deadline (i.e., April 15 of the following year).
Look into Using a Specific Identification Costing Method
After the new IRS cryptocurrency tax guidance came out in October 2019, it clarified that specific identification costing methods could be used when calculating your gains and losses for your cryptocurrency transactions provided that you had records to specifically identify your crypto.
This sounds a lot more complex than it is. Essentially, pre-2019, most Bitcoin and crypto investors were using the common First In, First Out (FIFO) calculation method to calculate their gains and losses from their trades (the cryptocurrencies that you bought first are sold first) because the IRS had not yet specified whether specific ID was allowed. Now that the new guidance makes this clear, specific identification is a great way to reduce your gains.
In using this strategy, you want to specifically identify and “sell” the cryptocurrencies that you bought at the highest price first. For active traders, this slight change can lead to huge tax savings.
Cryptocurrency tax calculators are especially good at applying these tax minimization algorithms like Highest In, First Out (HIFO) and Last In, First Out (LIFO).
However, before you can use a specific identification method, you have to be able to specifically identify a unit of cryptocurrency as the IRS outlines:
To specifically identify a unit of cryptocurrency, you must have records of the following information:
- The date and time each unit was acquired;
- Your basis and the fair market value of each unit at the time it was acquired;
- The date and time each unit was sold, exchanged or otherwise disposed of; and
- The fair market value of each unit when sold, exchanged or disposed of, and the amount of money or the value of property received for each unit.
If you have this data for your transactions, you are able to use specific identification methods like LIFO or HIFO which can drastically lower your cryptocurrency capital gains taxes.
Hold for Longer Than One Year
Similarly to the world of investing in stocks, holding onto a cryptocurrency investment for longer than one year pushes you out to the long-term capital gains tax rates. These are typically much lower than the short-term capital gains tax rates which apply when you have sold or traded out of your investment after holding onto it for less than one year.
Additionally, if you are able to identify your cryptocurrencies specifically, you can take advantage of this strategy further. You can specify that the coins you “sell” are the coins that you have held for longer than one year’s time. This will qualify you for the long-term capital gains rate and will help reduce your overall tax liability!
Invest Your Crypto Capital Gains into a Qualified Opportunity Zone Fund
Opportunity Zone Funds became part of the tax code with the Tax Cuts and Jobs Act of 2017. The IRS defines an Opportunity Zone as an “economically-distressed…