Crypto taxes can be heavy on the pocket; especially when you aren’t prepared for them. Since there isn’t too much awareness around crypto taxes yet, most of us tend to end up with a heavy crypto tax liability come tax season. However, in the past few years, there’s a lot more awareness around crypto taxes, and the IRS has cleared up a lot of the ambiguities surrounding the issue.
Which also means that serious crypto investors can now look into tax planning and make sure that they don’t feel the burden later on. If you want to reduce your crypto tax liability next year, there are some important things that you need to do today.
#1 Hodling: the key to long-term tax planning
It’s important to remember that the capital gains tax you incur on the disposal of your cryptocurrency (whether that’s selling your crypto for fiat or exchanging it for another cryptocurrency) will depend on how long you have held the crypto. If you hold the crypto for less than one year, you will be subject to short-term capital gains tax. This means your profits will be considered as ordinary income and taxed as per your income tax slab.
On the other hand, if you hold cryptocurrency for more than a year, you will be subject to long-term capital gains tax, which varies between 0-20% based on your income. You might argue of course that the whole point of crypto trading is the speedy transactions and short-term gains. In that case, borrowing fiat currency against your cryptocurrency as collateral is a great solution. Borrowing against crypto doesn’t lead to any tax liability; so you can take advantage of short-term liquidity and market appreciation without incurring a heavy tax burden.
#2 Get that paperwork in place: maintain complete and accurate records
This is one of the most important aspects of limiting your tax liability. You need to have complete and accurate records of your crypto transactions, not just for the assessment year but previous years as well. This will help you figure out the true cost basis of your transactions and calculate the crypto gains correctly from each transaction. If you maintain accurate records, you’ll avoid having to do guesswork or accidentally paying double tax for the same transaction. In case you haven’t been maintaining perfect records so far, you can always use crypto tax software to organize your transactions. This way, when it’s time to file your returns next year, all the information will be at your fingertips.
#3 Save taxes while making the world a better place: create a Charitable Remainder Trust
Charitable Remainder Trusts (CRTs) are a great tax planning vehicle that you can use to minimize your tax liability in the long run.
To leverage this tax planning vehicle, you need to first create a CRT and then transfer your crypto to the CRT. The trustee will then sell the crypto and invest the proceeds from the sale into other income-generating assets. If you use a CRT, you don’t have to pay any capital gains when the crypto is sold. In fact, you even get a charitable deduction when you transfer your crypto to the trust. The trust then pays you an annuity for the rest of your life, after which the assets go to charity. So you avoid a huge tax burden, receive income for the rest of your life, and help the world become a better place!
#4 Save for the future while also minimizing your tax bill: use a retirement account
If you buy cryptocurrency inside of a traditional IRA, 401-K, defined benefit, or any other retirement plan, you don’t need to pay any capital gains tax until you take distributions. If you buy cryptocurrency as part of a Roth IRA, you won’t have to pay any tax at all. So if you want to shore up some money for your retirement without incurring a huge tax liability, investing through a retirement account is a great idea. Keep in mind that in order to invest in crypto through your retirement account, you have to move the retirement account outside of the United States and into an offshore IRA LLC. The IRA LLC can then open an offshore bank account and wallet to make the investment.
#5 Don’t forget those deductions
Remember that deductions play a huge role in reducing that tax bill. So keep a detailed account of crypto-related expenses that you are incurring through the year. Of course, with the Tax Cuts and Jobs Act of 2017, you may not be able to use as many deductions now. At the same time, the standard deduction has doubled to $12000 so it might be a good idea to roughly estimate your expenses to see if it’s even worth keeping track of deductions or if the standard deduction would work better for you.
If you are engaging in a lot of crypto trades through the year, consider hiring a crypto tax professional. Although they tend to be expensive, they will help you plan your taxes in a way that will end up saving you loads of money in the long run.
This is a guest post by Robin Singh - the co-founder and CEO of Koinly.io - a cryptocurrency tax solution that solves capital gains reporting for crypto investors by automatically generating tax reports like Form 8949.