How To Avoid Taxes Legally With Bitcoin

Bitcoin and other cryptocurrencies are taxed in most countries, including the US, where the Internal Revenue Service (IRS) treats them as assets similar to property. This means that any gains or income from selling or using Bitcoin to purchase goods or services are generally taxable. However, there are some strategies that investors can employ to legally minimise or avoid paying taxes on their Bitcoin investments. These include:

- Holding Bitcoin for the long term: In the US, long-term capital gains (holding for more than a year) are taxed at a lower rate than short-term gains.

- Gifting Bitcoin to family members: In the US, gifting Bitcoin is usually not considered a taxable event, as long as the amount is below the annual gift tax exclusion limit ($18,000 in 2024).

- Using tax-loss harvesting: Investors can sell Bitcoin at a loss to offset gains made on other investments, reducing their overall tax liability.

- Buying Bitcoin in a tax-efficient account, such as an Individual Retirement Account (IRA): Gains made in an IRA are often tax-free or tax-deferred.

- Relocating to a country with more favourable tax treatment of Bitcoin, such as Puerto Rico or Portugal.

- Donating Bitcoin to charity: In the US, cryptocurrency donations are generally tax-deductible.

Capital gains and losses on sales of Bitcoin

Capital gains or losses on sales of Bitcoin are treated the same as other capital assets such as stocks, bonds, precious metals, or certain personal property. When you sell a virtual currency you've held for more than a year, you must recognise capital gains or losses on the sale. Any gain or loss is calculated based on the cryptocurrency's market value on the day and time you bought it (its basis).

The gains or losses recognised are subject to limitations on the deductibility of the taxpayer's capital losses. This tax legislation is determined by IRS Publication 544 (Sales and Other Dispositions of Assets). Capital gains are reported on Schedule D of a taxpayer's Form 1040.

In the broadest sense, short-term capital gains are taxed as ordinary income and assessed at the same tax rate as the taxpayer's salary or wages. Long-term capital gains are taxed at a rate that varies depending on the taxpayer's income.

For example, if you sell Bitcoin for less than you bought it for, the amount of the loss can offset the profit from other sales. If you sell Bitcoin for a profit, you're taxed on the difference between your purchase price and the proceeds of the sale.

The IRS has provided specific guidance on transactions involving digital assets that are to be included in a tax return. The extent of these transactions may make them difficult to track, so cryptocurrency investors and users are advised to seek tax advisor guidance to ensure that all transactions are adequately reported.

Tax implications of Bitcoin mining

The Internal Revenue Service (IRS) treats mined cryptocurrency as income. When you mine cryptocurrency, you trigger a taxable event and are taxed based on the fair market value of the coins at the time of receipt. The tax rate you pay on your mining income is dependent on your income level.

If you run a mining business, you can make deductions to cut down your tax bill. However, if you mine cryptocurrency for personal benefit, you cannot make these deductions.

If you mine cryptocurrency as a hobby, you will include the value of the coins earned as "Other Income" on line 2z of Form 1040 Schedule 1. While mining as a hobby, you are generally not allowed deductions to offset expenses like electricity and hardware costs.

On the other hand, if you run your mining operation as a business, you will report your income on Schedule C. In this case, you can fully deduct the expenses associated with your business.

If you mine cryptocurrency through a business, you can write off your expenses, including equipment, electricity, repairs, and rented space.

Tax implications of swaps

Swapping one cryptocurrency for another, such as exchanging Bitcoin for Ether, does not qualify as a like-kind transfer under Section 1031 of the Internal Revenue Code. This means that the conversion of one cryptocurrency to another is taxable. The IRS clarified this in a Memorandum from the Office of Chief Counsel released on June 18, 2021, stating that such exchanges do not qualify as a like-kind exchange under Section 1031. Furthermore, the Tax Cuts and Jobs Act (TCJA) of 2017 restricted like-kind transfers to property transactions.

If you receive cryptocurrency in a transaction performed via an exchange, the value of the digital currency received is recorded by the exchange at the time of the transaction. If the transaction is performed outside of the exchange (P2P), the basis of the cryptocurrency is the fair market value at the time.

The tax implications of swaps can be complex and depend on various factors, such as the value of the cryptocurrencies involved, the timing of the transaction, and the taxpayer's location. It is always recommended to consult with a tax professional to ensure compliance with the relevant tax laws and regulations.

Tax implications of hard forks

A 'hard fork' in the crypto world refers to a pivot or a programmatic rule change that has wide-ranging implications on the entire protocol of the blockchain network in question. This creates an 'old' and a 'new' version of the chain's associated cryptocurrency. Hard forks can occur when blockchain programmers want to increase its performance or address security risks. They can also occur if a blockchain has a governance process in place, where a DAO (made up of a particular chain or asset's users) votes to change certain aspects of the existing token.

The tax implications of a hard fork will depend on the specific jurisdiction. In the US, the IRS states that any new coins received as a result of a hard fork (e.g. Bitcoin holders receiving Bitcoin Cash) should be treated as ordinary income and will incur income tax. US crypto users need to calculate the fair market value of the coins they receive to determine how much income they've earned.

In the UK, HMRC has stated that coins received as a result of hard forks are not classified as income but are instead subject to capital gains tax when they are disposed of. Any profits or losses made from these coins would be relevant to an individual's capital gains taxes.

In Australia, the ATO guidelines state that when new cryptocurrency is received as a result of a hard fork, taxpayers do not earn income or make a capital gain at that point. Instead, a capital gain will arise when the new cryptocurrency is disposed of (via selling, swapping, exchanging, etc.), and the new cryptocurrency will have a zero-cost base for the purpose of determining any capital gain.

In Canada, at the time of writing, the CRA has not released specific guidelines for the treatment of tokens received as a result of hard forks. It is advised that individuals speak to a local tax professional to get advice on what is best for their personal circumstances.

Tax implications of gifting Bitcoin

Gifting someone Bitcoin is not a taxable event. The giver does not need to pay tax on any capital gains, and the recipient does not need to pay income tax. However, the recipient will need to pay capital gains tax if they dispose of the Bitcoin in the future.

In the US, the IRS established an annual gift tax exclusion. In 2023, taxpayers were allowed an annual exclusion per donee for a gift amount of up to $17,000. This limit was increased to $18,000 in 2024. If you gift more than this amount, you will need to file a gift tax return (IRS Form 709).

If you are gifting cryptocurrency to someone who has never had or used it before, you may want to encourage them to open an account with one of the large digital asset platforms such as Coinbase, Robinhood Crypto, or Gemini. These platforms are easy to navigate and operate much like a stock trading platform.

It is important to note that transactions cannot be reversed or changed. Before sending a gift, ensure it is going to the correct wallet. The recipient should also be made aware of the risk of any transfers they make of the gifted cryptocurrency.

Frequently asked questions