Tax Strategies For Cryptocurrency Investors To Legally Minimize Taxes

Many cryptocurrency investors and taxpayers view the tax system as a drain on their wealth. They often say, if it wasn’t for taxes, I would have more funds to accelerate the growth of my portfolio and build wealth for my family.

I have a different perspective on the tax code. If you follow the rules, you should enjoy legal tax deductions and be well-prepared for an audit. The challenge most people have with this is they don’t know the rules.

If the tax code was written just to tell you how to pay taxes it probably wouldn’t be more than 50 pages rather than 60,000 plus pages it currently stands at. The majority of the tax law is actually intended to reduce your taxes – not increase it. The tax code is an incentive system designed by the government that serves as a map to show you how to create and keep wealth for yourself.

Now I will agree, taxes don’t just steal your money, they steal your time. Building wealth is not about what you make but what you keep. Without a foundational tax strategy, taxes can easily drain a person’s cash flow and their ability to build wealth.

Once you understand what the government wants you to do in order to reduce your taxes, you can use this information in your wealth and investment strategy. Below we will review some of the tax strategies that apply to cryptocurrency investors.

The key with any of these strategies is to be proactive not reactive. If you wait until you are filing your taxes during March or April to think about your taxes, you are too late and Uncle Sam wins. You need to consider and implement a foundational tax strategy for your portfolio well before tax season and also before liquidating any large amount of holdings.

Know Your Numbers

The key to properly implementing any tax strategy is first knowing where you currently stand. This means that you have to accurately calculate your portfolio to date to know what you owe in taxes currently based on your trades and know the cost basis of your current holdings.

Both your cost basis and current tax liability will drive any tax strategy.

Additionally, accurately calculating your portfolio will protect your assets from interest and penalties charged by the IRS. It is no news that the IRS is zeroing in on cryptocurrency investors and the efforts here will only increase with time.

Make sure you work with an experienced cryptocurrency CPA and not an accountant who is rushing into the space to make a quick buck when calculating and analyzing your portfolio.

Strategically Minimize Capital Gains

The simplest way to minimize capital gains is to avoid triggering additional capital gains. The current taxation structure that applies to transacting in cryptocurrency makes this difficult since anytime you trade or spend cryptocurrency this is a taxable event.

One thing to keep an eye on here is a new bill called HR 3963 introduced on the House floor very recently. This would be great for cryptocurrency investors and the industry if this was passed. I am not very hopeful but watching this closely. HR 3963, also called the Virtual Value Tax Fairness Act of 2019 would restore this 1031 exemption for digital assets under a five-year sunset provision.

In the meantime, as always, all cryptocurrency transactions are taxable events and should be reported accordingly. When investing and trading cryptocurrency it should stay top of mind that anytime you transact in crypto, it’s a taxable event. Cryptocurrency investors should be careful to choose their trades carefully and minimize them as much as possible.

Know Your Holding Periods

After you calculate your current portfolio positions it is important to analyze your current holding period on all your assets.

I recently worked with a new client and discovered after analyzing their portfolio that they could have saved over $340,000 if they had waited just four extra days to liquidate their holdings.

This is because anytime you hold your cryptocurrency over 365 days it will be taxed at long-term capital gains rates which are significantly more favorable than the alternative short-term capital gain rates.

Make Sure You Maximize Your Losses

If your capital losses in 2018 exceed your capital gains, then you will have a carryover loss that can be used to offset gains in future years. It is important to note that losses cannot be carried back to previous tax years.

Do not make the mistake of not including your capital losses from 2018 which were not deducted during the tax year on last year’s return.

One very large benefit for cryptocurrency investors is a consequence of the current taxation structure for cryptocurrency which treats cryptocurrency as property. This means that wash sales most likely do not apply to cryptocurrency. Today, wash sales only apply to stocks and securities.

This means investors can sell an investment to realize a tax loss, only to buy it back immediately thereafter to maintain their trading position.

After you analyze your current cost basis, compare this to the current market rate for your holdings. After considering implications to your holding periods, harvest your applicable losses to offset your gains for current and future tax years.

Gifting or Donating Cryptocurrency

Giving cryptocurrency as a gift or a donation is not a taxable event. However, while the recipient inherits the cost basis, the gift tax still applies if you exceed the gift tax exemption amount.

This is a great way to strategically shift cryptocurrency to friends or family without incurring a reportable taxable event.

Opportunity Zones

The Tax Cuts and Jobs Act created a new investment vehicle called an Opportunity Fund. The new investment vehicle is designed to spur economic development by providing tax benefits to investors in low-income communities, known as Qualified Opportunity Zones.

This has many similar features to like-kind exchanges but are eligible from gains from cryptocurrency assets among other assets. This is a complicated tax vehicle which cannot be fully explained in one article.

You get to defer tax on any capital gains that are reinvested within 180 days into an Opportunity Fund.

The basis of the original investment is increased by 10% if the investment in the qualified opportunity zone fund is held by the taxpayer for at least 5 years, and by an additional 5% if held for at least 7 years, excluding up to 15% of the capital gains from taxation.

Also, if you don’t sell the investment for 10 years, you do not have to pay capital gains taxes on any returns you received from the Opportunity Fund.

This is a great way not only to defer but also reduce your overall tax burden from liquidating cryptocurrency. Like any advanced planning strategy there are detailed considerations here which should be discussed with your CPA well before you implement this strategy.

Charitable Remainder Trusts

Charitable Remainder Trusts are a powerful tax vehicle for anyone that holds highly appreciated assets including cryptocurrencies. This is also a complicated tax vehicle which cannot be fully explained in one article.

The basics which are vital to know for preliminary considerations are that you can transfer your cryptocurrency assets into an irrevocable trust.  The trustee then sells the asset at full market value and re-invests the proceeds into other income-producing assets.

You pay no capital gains tax when the asset is sold, and you also receive a charitable deduction based on the fair market value of property transferred to the trust. This means that when you sell your cryptocurrency by first strategically transferring it to a Charitable Remainder Trusts you will actually get a tax deduction rather than a tax bill.

The deduction is based on the amount of income received, the type and value of the asset, the ages of the people receiving the income, and the Section 7520 rate, which fluctuates. It is usually limited to 30% of adjusted gross income, but can vary from 20% to 50%, depending on how the IRS defines the charity and the type of asset.

If you can’t use the full deduction the first year, you can carry it forward for up to five additional years. Depending on your tax bracket, type of asset and type of charity, the charitable deduction could possibly reduce your income taxes by 10%, 20%, 30% or in some cases even more.

The trust then pays you an annuity for the rest of your life, and when you die, the remaining trust assets go to charity.  As a result, CRTs make it possible to reduce current year taxes while allowing you to convert highly appreciated assets into a lifetime income stream.

This is a great way not only to defer but also reduce your overall tax burden from liquidating cryptocurrency. Like any advanced planning strategy there are detailed considerations here which should be discussed with your CPA well before you implement this strategy.

Stay Up To Date On Regulatory Developments

The cryptocurrency tax landscape is rapidly developing much like the overall industry, and the pace of that change is faster now than at any time in previous years.

Just during 2019 alone we have seen the IRS take further steps in crypto-tax enforcement by issuing various notices to identified cryptocurrency holders. We have also seen documents publicly available which cite further plans for enforcement which are outside the scope of this article.

Additionally, we have seen further clarification on issues such as foreign reporting in addition to proposed bills such as Virtual Value Tax Fairness Act of 2019 would restore this 1031 exemption for digital assets which was previously cited in this article.

Needless to say, there will be additional developments sooner than later.

Tax planning and compliance for cryptocurrency are evolving, and increased tax authority scrutiny will cause a jump in the number and size of cryptocurrency tax audits and assessments in the future. There also can be new opportunities to minimize your taxes given further clarity and updates to the regulations.

Investors and businesses who work to make sense of the shifting cryptocurrency tax landscape must remain diligent in staying up-to-date on the latest developments in IRS legislation and tax treatments surrounding various forms of cryptocurrency transactions.

About The Author: Patrick Camuso, CPA is founder and owner of Camuso CPA a CPA firm serving cryptocurrency investors, miners and businesses nationwide. Camuso CPA was the first CPA firm in the United States to accept cryptocurrency as a form of payment for professional services. Camuso CPA works with investors, funds and businesses on cryptocurrency portfolio tax analysis, tax preparation and tax planning.