Investing in cryptocurrency can be lucrative, but like any investment, come tax season, you’ll need to show your hand and pay some taxes. Any time you’re profiting off of crypto, the IRS wants to know about it and you will have a tax bill. Even though many crypto tax regulations are still being sorted, the US government still expects you to pay your fair share of crypto taxes.
That doesn’t mean there aren’t some methods to lower your tax bill or reduce how much you pay in crypto taxes. But there’s also some advice floating around that can get you in legal trouble.
Here’s everything you need to know about lowering your crypto tax bill, legally.
How to stay tax compliant when investing in cryptocurrency
The IRS requires you to report your crypto activity each year. Not reporting your activity can be considered tax evasion, which is against the law. Unfortunately, tax evasion can happen purposefully and accidentally. That’s why it’s important to understand that anytime you sell or trade crypto and anytime you buy assets with crypto, you’re triggering a taxable event that has tax liability.
Crypto taxes can be complicated, which is why we always recommend talking to a tax professional if you have any questions about what to report on your tax returns.
Run, don’t walk from these crypto tax evasion strategies
Let’s start by explaining some methods of avoiding crypto taxes that aren’t legal and that you should never use, specifically tax evasion.
There are two types of tax evasion: evasion of assessment and evasion of payment.
Crypto evasion of assessment
Crypto tax evasion of assessment occurs when a taxpayer willingly underreports or fails to report their cryptocurrency transactions. This includes capital gains (both short and long term capital gains are elibible) , wages, and additional income received in cryptocurrency.
For instance, if you earn $3,000 in capital gains in cryptocurrency in 2022, you would need to report this on your 2023 taxes. An example of evasion of assessment would be only reporting capital gains of $1,000 to lower your tax bill or not reporting your crypto capital gains at all.
This is the most common type of crypto tax evasion, and one that the IRS warned it would be on the lookout for when tax returns are filed.
Crypto evasion of payment
Less common in the crypto space is evasion of payment. This type of evasion occurs after a tax bill has been issued, and an individual tries to hide funds that could pay off their tax bill.
6 Legal Ways to Avoid or Reduce Crypto Taxes in 2022
Now that you understand the crypto tax evasion methods that can land you in legal trouble, there are some ways to offset, lower, defer, and even eliminate taxes on your cryptocurrency sales and trades. Here are some options to consider to lower your crypto tax bill.
1. When in doubt, HODL
While you can’t avoid crypto taxes completely, you can make some decisions to push out your tax due date. Holding on to your crypto and not selling or trading it is an easy way to avoid a hefty crypto tax bill at the end of the year. You wont owe any capital gains taxes if you have no capital gains (or losses) to report.
You’ll eventually owe taxes when you do decide to sell or trade your cryptocurrency, but if you’re not ready to incur a tax bill — keep on holding and you won’t need to pay taxes on capital gains yet.
2. Wait to sell for at least one year
Another strategy to lower your crypto tax bill is by aiming to lower your capital gains rate. When you sell your cryptocurrency, you incur capital gains, a tax that you owe when making a profit off of the sale of most assets, from property to Bitcoin.
However, there are two types of capital gains rates — long-term and short-term capital gains. Short-term capital gains tax applies if you sell your crypto after owning it for less than a year. What happens is that the profit of your sale is added to your taxable income for the year.
For example, if you make a $10,000 profit after selling your stash of Bitcoin, this $10k is added to your adjusted gross income (the amount you make per year, minus any deductions). So, let’s say you made ordinary income $42,000 in 2022 from your job. Your crypto sale would bump up your taxable income to $52,000, and you’d pay 22% in income taxes on your crypto profit. This would equal around $2200 (for your crypto taxes, alone). The tax rate on Short term capital gains depends on your income level and household status (single vs married etc) but it varies from 10% up to 37% in a higher tax bracket States also require you to pay taxes on short term gains with some states like California requiring it as income tax at 13.3%
But, if you hold on to your crypto for a year or more, you qualify for the long-term capital gains tax rate. These rates vary based on your income, but are typically more affordable than short-term capital gains tax rates. Using the example above, you’d qualify for the 15% capital gains tax rate, which would set your capital gains tax at about $1500. Note that the capital gain rate of 15% is only at a federal level and your state tax rate will be additional.
This means you’d save roughly $700 in crypto taxes by waiting and selling after a year (assuming you’d make the same profit). You will always have to pay capital gains taxes but
3. Offset your gains with losses
Another strategy to lower (and possibly eliminate) your crypto tax bill is to try to offset any gains you made with losses.
For instance, if you made some gains earlier this year, you could lower your tax bill by selling some of the crypto you’re currently holding at a loss.
This strategy makes the most sense when you’re holding a cryptocurrency that you don’t expect will pick up in value any time soon.
So, for example, if you earned $20,000 by selling crypto assets earlier in the year, you could offset the taxes you’ll pay by also reporting the $20,000 loss you experienced when a nft you bought for $30,000 and is now worth 10,000 in fair market value is sold. In this case, you would break even, and not need to pay taxes on crypto
In the event that your losses exceed your gains, however, you can lower your taxable income by $3,000 or the amount of your loss — whichever is lower. This $3,000 per year only counts against your income tax. If you expect to make future gains in cryptocurrency, you can also carry any capital losses forward to other tax years, to help offset future capital gains.
Note: The wash sale rule says that investors are not allowed to claim capital losses on a stock sale if they buy the same stock 30 days before or after the sale. However, cryptocurrency is currently treated as property, and not like stock. That means the wash sales rule typically does not apply to crypto. So, if you sell Bitcoin at a loss to offset your taxes, you could technically rebuy Bitcoin within 30 days. However, legislatures are working to include crypto in the wash sale rule, so we recommend talking to a tax professional whenever claiming cryptocurrency losses on your tax returns.
4. Opt for crypto IRAs or pensions
If you’re looking for ways to get into cryptocurrency without incurring taxes right away, investing in self-directed IRAs, pensions, or other retirement accounts that include cryptocurrency is one way to dabble in digital trading, while deferring your tax bill.
In this instance, any cryptocurrency trading would not be taxed right away — instead it would be taxed at the time you withdraw the money, giving your crypto more time to appreciate and grow. Certain other forms of crypto ira’s like ROTH IRA you pay taxs on the money going in but then can trade as much as you want with that money and not owe any additional federal taxes.
5. Gift your crypto
Another way to avoid paying taxes on cryptocurrencies gains is to gift your crypto. In the US gifts under $16,000 remain tax free. So, if you made $10,000 in crypto gains this year, you could gift this cryptocurrency to someone else, to avoid paying capital gains.
The recipient also wouldn’t owe taxes on this gift, since it’s under the $16,000 IRS gift tax threshold.
6. Donate your crypto to charity
If you want to lower your tax bill, while giving back to an organization in need, you could send some of your crypto profits to an eligible charity with 501(c)3 status. Donation to eligible charities are tax deductible meaning you’ll then be able to claim a deduction for the amount you gifted, the lower, and in some cases, completely eliminate your crypto taxes for the year.
Make sure your crypto taxes are done right to save money
One of the best ways to make sure you don’t overpay on your taxes — both personal and crypto — is by partnering with an experienced tax professional. Whenever cryptocurrency is involved in your taxes, a tax professional with digital asset experience may be the best way to spot opportunities to minimize your tax burden.
A qualified tax professional can make sure you remain tax compliant, while finding you ways to reduce your tax bill, legally. We especially recommend talking to an accountant if you regularly make money off of cryptocurrency, mine crypto, or work as a digital NFT creator. Crypto Investors with complicated portfolios can face a massive tax burden that is complex and confusing to decipher. Working with a professional can be the only way to figure out what you owe. Whenever self-employment taxes are involved, your tax return becomes more complicated — and often more expenses. A certified professional accountant who understands the current cryptocurrency tax laws is the best way to identify tax savings opportunities.
If you’d rather do your cryptocurrency taxes yourself, we recommend using a crypto tax service that easily integrates with the online tax platform you regularly use. For example, CoinTracker has partnered up with TurboTax to make tracking and uploading your cryptocurrency transactions a breeze, so your taxes are much easier to calculate and verify. There are also several other services, like Koinly, you can use to help compile your transactions to make them easier to upload and check when filing with online tax software.
We recommend comparing the cost of hiring a CPA against crypto tax software, especially if you’re self-employed. Many times, tax software can be more expensive than working with an accountant if your taxes are particularly complicated.