As time goes on, crypto-currency continues its evolution from a niche technological experiment to the newest global investment asset class worth trillions of dollars, with millions of investors worldwide now buying, selling, trading, staking, and holding digital assets such as Bitcoin and Ethereum, plus countless other altcoins. It’s no surprise to anyone that crypto has been attracting investors to take advantage of the profit potential; however, most investors may be unaware of the tax implications associated with these gains and that, in many jurisdictions, cryptocurrency transactions constitute taxable events, meaning the profits you generate through trading or investing in cryptocurrency will lead to substantial tax liability.
Fortunately, it is possible to reduce your crypto tax liability legally. Tax planning isn’t about hiding income or otherwise avoiding your legal tax obligations; it’s about educating yourself on the laws surrounding cryptocurrencies so you can make smart financial choices and take advantage of legitimate tax-saving opportunities under the law. Additionally, investors who take an active role in managing their cryptocurrency portfolios often find they pay much lower taxes than those who do not think about their crypto tax obligations until the end of the tax year.
Our goal is to provide you with comprehensive, actionable strategies that will allow you as an investor in crypto currencies to legally minimize your tax liability while complying with all relevant laws. Many of these approaches have been successfully employed by countless others (including both individual and institutional investors) and have proven helpful to them in generating greater returns after taxes and building wealth over the long term at a much faster rate.
Understanding How Crypto Taxes Work
To be able to create a tax-efficient strategy for investing in cryptocurrencies and saving taxes with any of your cryptocurrency investments, it is critical that you first understand taxation on cryptocurrency. In many situations, cryptocurrencies are treated as property, capital assets or investment assets — not as currencies. Thus, if you sell cryptocurrency for a profit, you are going to trigger capital gains tax. Likewise, if you earn income from staking rewards, mining income, airdrops, and yield farming, the IRS may consider those earnings to be income subject to taxation.
It’s common for many investors to believe that they only incur taxes when they actually convert their cryptocurrencies into fiat currency. However, many taxable events can happen when you exchange one cryptocurrency for another, spend your cryptocurrencies on goods and/or services or even receive rewards from various networks on the blockchain. Understanding these various rules will be the first step to creating a tax-efficient strategy for your cryptocurrency investments.
Hold Investments for the Long Term
Holding an asset for an extended period of time is very easy to do and one of the most efficient strategies to lower your legal liability for crypto taxes. Many tax jurisdictions tax long-term capital gains on investments at a lower rate than the corresponding short-term capital gains taxes. Therefore, if you frequently acquire and dispose of your crypto assets, your profit will be considered short-term gains resulting in a higher tax obligation for the profits you realize upon liquidation.
In addition to obtaining favourable tax treatment as a result of holding assets for an extended period of time, investors can benefit from lower trading commissions and emotions resulting from making short-term transactions. Many successful crypto investors espouse a long-term investment strategy because they believe in the future growth of blockchain technology and digital assets. In addition to the tax benefit of holding assets over a longer time horizon, a long-term investment plan is also likely to help investors create an overall more stable portfolio and to build greater self-discipline as an investor.
Use Tax-Loss Harvesting
Tax-loss harvesting, which is the selling of depreciated assets in order to take advantage of tax laws, is one of the best ways to reduce taxes legally for cryptocurrency investors. By selling depreciated assets and realizing these losses, a taxpayer can then offset other gains from their entire portfolio with the loss amount.
Let’s say that you have gained a significant profit through trading Bitcoin, but have realized a loss through other cryptocurrencies. The tax-loss harvesting strategy would allow you to offset your total gain from Bitcoin by realizing a loss from other cryptocurrency assets. In some areas, you may also be able to carry over the losses into the following year for additional tax savings.
While tax-loss harvest could reduce your overall risk as an investor, it can increase your overall returns after taxes have been deducted if executed properly. Therefore, many experienced investors will systematically review their investment portfolios before the end of the tax year to find opportunities to harvest losses in an effort to reduce their tax liability.
Maintain Accurate Records of Every Transaction
Accurate recordkeeping might be viewed only as something that helps avoid mistakes with tax but, in reality, it is an important component of reducing the burden of taxes on a taxpayer. Cryptocurrency Investors frequently utilize a multitude of exchanges, wallets and other decentralized finance (“DeFi”) platforms making it challenging to ascertain the way all of these transactions correspond with one another.
If an Investor does not maintain accurate records, they will likely have difficulty determining their cost basis correctly. This can occur when tax is paid for the excess of selling price over cost basis or penalties are imposed for reporting incorrectly.
By keeping detailed records of transactions related to purchases, sales, transfers, staking rewards and fees creates certainty that all of the taxable gains realized from those transactions would be accurately calculated.
Crypto tax software has simplified this task by importing transaction transactions (irrespective of the exchange or wallet used to conduct the transaction) therefore lessening the burden placed on the Investor when filing taxes. Maintaining organized records not only makes it easier to file taxes, but may also help taxpayers identify additional deductions and/or value enhancing opportunities that would otherwise not be recognized.
Consider Tax-Advantaged Investment Accounts
In some parts of the world those who invest in cryptocurrencies may also be able to invest through accounts with tax benefits such as retirement or similar types of accounts. These accounts may provide tax-deferred growth opportunities; lower rates of income tax; or in certain circumstances, tax-free withdrawals.
Although direct ownership of cryptocurrency isn’t necessarily allowed through these types of accounts, there are many options available to investors including, but not limited to: crypto ETFs, blockchain-based mutual funds, and other regulated investment products. By investing in cryptocurrencies through tax-optimized accounts, investors can substantially lower their future tax obligations while enhancing the overall performance of their portfolios.
Investors must conduct due diligence on the options available to them in their residence, and seek advice from professionals when needed to make an informed investment decision.
Offset Crypto Gains With Other Investment Losses
Tax planning is best undertaken by taking a broader view of your portfolio, as opposed to treating cryptos as isolated transactions. In some jurisdictions, losses from stocks, mutual funds, ETFs and other investments can be used to offset your capital gains you realize here in cryptos.
A broader tax management approach will allow you to optimize all of your taxes instead of just on each of your individual investments. Also, the end of the financial year is an ideal time to strategically rebalance your portfolio, which could reduce your taxable gains while maintaining a diversified investment profile.
While differences exist in taxation rules between different countries, those investors who have an understanding of how gains/losses play off each other across different asset classes generally will be more tax efficient relative to those investors who focus only on crypto transactions.
Be Strategic With Staking and Passive Income Activities
Using cryptocurrency to make money passively by staking your own coins is becoming quite popular. Staking rewards can produce good returns, however, they will also create additional tax implications for you because the majority of the world’s tax authorities will consider your staking rewards as taxable income at the time that you earn them.
In order to participate in a staking program, you need to think about how the taxes from the staking will affect you. It’s possible that the amount of money you make from the staking could cause you to go into a higher tax bracket, or create additional reporting responsibility for you.
It does not mean that you should completely avoid staking. You need to plan for the tax implications when you create your overall investment strategy, and also make sure you track and report all of your staking rewards correctly. Understanding when you get taxed on your staking rewards can help you avoid surprises, and can improve your long term tax planning strategy.
Avoid Emotional and Excessive Trading
Investors in cryptocurrency are often driven to make a different decision based on market changes. The potential for profit and gain coming from actively trading is attractive; however, these events will lead to heightened tax obligations, greater fees associated with each transaction, and far more complex record-keeping.
The frequency of trading in cryptocurrencies creates many different taxable events for an investor. Therefore, they will have trouble managing gains and losses in an efficient manner over the course of the year. Additionally, profit made in short positions receives a higher tax rate than would normally be incurred on long-held investments.
Steady, disciplined investing that focuses on clearly defined goals and a long-term approach will prevent tax liability from being created due to unnecessary events. Investors who do not act on their emotions when investing and keep their trading frequency low may achieve greater overall returns and greater tax efficiency on their investments.
Stay Updated on Changing Tax Regulations
Governments around the world are continuing to change the rules governing virtual currencies (cryptocurrencies) due to increased use and popularity of these digital assets. As a result, laws that apply to cryptocurrencies today may not necessarily be applicable tomorrow and may even create new opportunities and obligations for certain types of investors.
It is extremely important for all investors to keep abreast of developments related to regulation, including rules about taxation. Each investor should be reviewing the pertinent government’s website on an ongoing basis for guidance on the tax implications of their investments in cryptocurrencies, as well as monitoring regulation changes which may impact their taxes on cryptocurrencies as they occur. By doing this, each investor can respond more proactively to new regulations versus reactively after those new regulations have come into effect.
An investment professional with cryptocurrency expertise can be a tremendous asset, allowing all investors to remain compliant as well as benefit from insight into the changes associated with cryptocurrencies and their corresponding taxation requirements.
The Importance of Professional Tax Advice
There are several ways to save on taxes, but many investors will require some assistance due to the complexity of their crypto holdings. Many investors engaging in staking, DeFi, trading NFTs, mining and/or conducting transactions in crypto globally may have unique tax challenges and will need specialized tax expertise.
A qualified tax professional can assist in finding deductions, optimizing investment structures and ensuring that taxpayers are accurately reporting their taxes. High-net-worth individuals who actively trade will typically benefit from hiring a tax professional, given that their tax situations generally involve multiple sources of income, as well as multiple taxing jurisdictions.
Costs associated with hiring a tax professional are usually far less than the potential penalties, mistakes and opportunities that will be lost due to improper tax planning.
Conclusion
The act of reducing your taxes from cryptocurrency is not about cheating the IRS out of taxes, or finding loopholes to evade your tax obligation. Rather, it involves the use of various strategies that enable you to understand how cryptocurrency taxation works, as well as how you can make informed decisions that will provide you with the greatest possible tax efficiency. Examples of how to reduce your taxes from cryptocurrency investment are: holding your investments for longer than one year; utilising tax-loss harvesting and accurately tracking your trades; leveraging the benefits of tax-advantaged accounts; and strategically managing your overall portfolio gains/losses.
