Maintaining your cryptocurrency tax liability is vital in adhering to IRS regulations, from accurately accounting for capital gains and losses, offsetting them against each other using methods like tax-loss harvesting.
The IRS considers cryptocurrency to be property, so any sale or exchange triggers taxes. Gains are taxed at your capital gains rate which varies based on both how much was sold for and its cost basis.
Capital Gains
As soon as you sell crypto for a profit, capital gains taxes will apply. You can manage this liability through proper record keeping and employing techniques such as tax loss harvesting or donating crypto to registered nonprofits.
If you regularly trade or receive cryptocurrency as gifts, their transactions could be considered income rather than capital gains. Such transactions could include staking and mining rewards, non-fungible token (NFT) sales or new coins from hard forks; you should report these on IRS Form 1040 and Schedule 1.
Long-term gains differ from stock trades in that their tax rates depend on how long you’ve held your crypto assets and your income level. Holding for longer can lower taxes through qualifying for reduced capital gains tax rates, or by using retirement accounts or moving to an income-tax-free state; they could even decrease by switching accounting methods like moving average or total average methods.
Depreciation
Cryptocurrency taxes can be complex and require extensive recordkeeping and an in-depth knowledge of tax rules to effectively navigate. This is particularly crucial given the IRS’s tendency to change guidance and forms regularly; failing to file properly could result in expensive audits from tax authorities that could take months or years to resolve.
Reducing capital gains taxes by selling cryptocurrency during years with lower income levels can significantly lower tax liability, and enable individuals to take advantage of lower capital gains rates.
Tax loss harvesting should also be utilized, which involves selling underperforming positions to offset realized gains and lower overall tax liability. However, this strategy must be executed carefully so as to not violate the wash-sale rule and risk potential tax benefits being lost later on.
Realized Losses
Investors holding cryptocurrency investments that fall in value may have unrealized losses that they can use to offset other trade gains, thereby lowering taxes overall and creating significant tax loss harvesting opportunities. This strategy can be particularly helpful in volatile crypto bear markets or when stock market losses increase significantly – this method is known as tax loss harvesting.
Investors paying taxes on cryptocurrency income can reduce their tax bills by making donations of cryptocurrency to IRS-recognized charities, which are tax-deductible. Gifting it to friends and family or transferring it into tax-advantaged accounts are also effective solutions for tax savings.
Investors should use quarterly estimated tax payments to reduce their taxable liability and avoid costly IRS penalties. While cryptocurrency taxes are complex, investors can save money with proper guidance and tools.
Tax-Loss Harvesting
Utilizing realized losses from one investment to offset capital gains in another is an effective tax-loss harvesting strategy, helping you lower your tax liability while keeping more of your portfolio working for you through compound growth.
Idealy, your gains from selling stocks should be lower than their losses in order to optimize this strategy and its benefits. In order to do so, accurate tracking must be undertaken in order to make sure your adjusted basis remains correct.
Tax-loss harvesting can be beneficial to investors in any market condition, but especially so in bear markets as more positions in your portfolio likely lost value rather than gained it.
Tax-loss harvesting typically requires a substantial portfolio, as transaction costs (brokerage commissions and bid-ask spreads) can eat away at your savings from these trades. Thanks to advances in fintech, transaction costs have become lower; making tax-loss harvesting more feasible for smaller investors.