Minimizing Crypto Investment Taxes: Strategies For Savvy Investors

Investing in cryptocurrency is risky, but it can also be lucrative. However, the IRS considers cryptocurrency a standard type of property, so any gains made from selling it are taxed as capital gains. There are, however, a number of legal strategies that can be used to reduce your crypto tax bill. These include tax loss harvesting, donating or gifting crypto, and investing for long-term capital gains.

Take advantage of long-term tax rates

Holding your cryptocurrency for at least a year can significantly reduce your tax bill. This is because, in most countries, the tax rate for long-term capital gains is lower than the rate for short-term capital gains.

In the US, for example, the long-term capital gains tax rate is between 0% and 20%, while the short-term capital gains tax rate can be as high as 37%. The exact rate depends on your income level and filing status. For instance, if you are married and filing jointly, you can earn up to $80,000 in income (including both crypto and non-crypto) and pay zero capital gains tax on your crypto gains, provided they are long-term and within the $80,000 limit.

In addition to taking advantage of long-term tax rates, there are several other strategies you can use to lower your crypto investment taxes. These include:

• Harvesting your crypto losses: Selling your cryptocurrency at a loss can help offset capital gains and reduce your overall tax liability.
• Donating crypto to charity: Crypto donations to qualified charities are tax-deductible, and you don't have to pay taxes on the capital gains from the donated crypto.
• Using a Self-Directed IRA (SDIRA): Investing in crypto through a SDIRA allows you to defer taxes until retirement and compound your crypto profits tax-deferred.
• Moving to a low- or no-income tax state or country: By relocating to a jurisdiction with lower crypto tax rates, you can reduce your overall tax burden.

Take profits in a low-income year

Taking profits in a low-income year is a strategy that can help you reduce your crypto tax bill. The basic idea is to sell or dispose of your cryptocurrency in a year when your income is lower than you expect it to be in the future. By doing this, you will pay lower tax rates on your cryptocurrency profits.

Here's how it works: The tax rate you pay on cryptocurrency sales or disposals depends on your income tax bracket for that particular year. So, if you sell crypto in a year when your income is low, you will fall into a lower income tax bracket, and thus pay a lower tax rate on your crypto profits. This strategy is especially useful if you are studying full-time or in between jobs, as your annual income will likely be lower during these periods.

For example, let's say you are a student and your annual income for the year is $20,000. You also have $5,000 worth of cryptocurrency profits that you want to sell. By selling your crypto in this low-income year, you will pay a lower tax rate on those profits compared to if you sold them in a year when your income is higher.

It's important to note that this strategy only works if you actually have a low-income year. You cannot artificially create a low-income year by deferring income or claiming excessive deductions. It simply means that you take advantage of a year when your income is naturally lower to reduce your overall tax burden.

Additionally, this strategy should be used in conjunction with other tax-saving strategies, such as holding your crypto for the long term (at least 12 months) to qualify for long-term capital gains tax rates, which are typically lower than short-term rates. You can also consider donating or gifting crypto, as these are not subject to tax in most cases and can provide additional tax benefits.

Give cryptocurrency gifts

Giving cryptocurrency as a gift is a great way to share your digital wealth with friends and family. It is also an effective strategy to lower your crypto tax bill. Here are some key things to know about giving crypto gifts:

No Immediate Tax Implications

Giving or receiving a cryptocurrency gift does not trigger a taxable event in most cases. This means that you, as the giver, do not have to pay taxes on the gift right away. Similarly, the recipient does not need to recognise the crypto gift as income and can avoid immediate tax consequences.

Gift Value Threshold

However, it is important to note that there is a gift value threshold for tax-free giving. In 2024, gifts of cryptocurrency below $18,000 are tax-free and do not require reporting to the IRS. If you give crypto gifts exceeding this amount, you will need to notify the IRS by submitting Form 709. These gifts count against your lifetime gift exemption, which is $13.61 million in 2024.

Tax Implications for the Recipient

While receiving a crypto gift is generally tax-free, the recipient should be aware of potential tax implications when they decide to sell or dispose of the crypto gift in the future. At that point, they may be subject to capital gains or losses, depending on whether the cryptocurrency's value has increased or decreased since they received it.

Cost Basis Information

When giving a crypto gift, it is essential to provide the recipient with information about the cost basis of the asset. This includes details such as the date of acquisition, the cost basis, and the fair market value of the cryptocurrency at the time of the gift. This information will help the recipient calculate their capital gains or losses when they eventually sell or dispose of the crypto.

Letter of Documentation

To ensure a smooth process, it is recommended to include a letter of documentation with the gift. This letter should include the identities of the giver and recipient, the date of the gift, the fair market value of the gift, and a statement confirming that the gift is not expected to be repaid. This letter serves as a legal declaration and helps both parties understand their tax obligations.

Crypto Gifts to Charities

In addition to giving crypto gifts to friends and family, you can also consider donating cryptocurrency to recognised nonprofits or charitable organisations. Crypto donations to IRS-recognised 501(c)(3) organisations are not subject to capital gains taxes and may be tax-deductible. By donating crypto, you can support charitable causes while potentially reducing your income tax liability.

Buy and sell cryptocurrency in an IRA

Investing in cryptocurrencies through an IRA can be a great way to reduce your tax burden. Here's a detailed guide on buying and selling cryptocurrency in an IRA:

Understanding IRAs

IRAs, or Individual Retirement Accounts, are tax-advantaged vehicles that allow you to save for retirement while offering certain tax benefits. There are different types of IRAs, such as Traditional IRAs and Roth IRAs, each with its own set of rules and tax advantages. When using an IRA to invest in cryptocurrencies, you can benefit from tax-deferred growth or even tax-free gains, depending on the type of IRA you choose.

Choosing a Crypto IRA Platform

When it comes to selecting a platform to open your Crypto IRA, you have several options. Popular choices include Bitcoin IRA, Bit IRA, iTrustCapital, Directed IRA, and Gemini. These platforms specialize in offering IRAs that allow you to invest directly in cryptocurrencies. They offer a range of cryptocurrencies, such as Bitcoin, Ethereum, Litecoin, and more. Be sure to compare the fees charged by each platform, as they may vary.

Opening Your Crypto IRA Account

The process of opening a Crypto IRA account is relatively straightforward. You'll need to fill out an application form and provide government-issued identification, such as a driver's license or passport. Some platforms may also require additional documentation. Once your account is approved, you can fund it by transferring or rolling over existing retirement funds or making new contributions.

Buying and Selling Cryptocurrency

With your Crypto IRA account set up, you can start buying and selling cryptocurrencies. It's important to remember that you are limited to investing only the funds that are within your IRA. You cannot transfer any cryptocurrency you already own into the IRA. The buying and selling process is similar to that of a standard brokerage account, but be mindful of transaction fees, as they can impact your overall returns.

Understanding the Tax Advantages

One of the biggest benefits of using a Crypto IRA is the tax advantages it offers. With a Traditional IRA, your contributions may be tax-deductible, meaning you can lower your taxable income in the year you make the contribution. On the other hand, with a Roth IRA, you don't get an immediate tax deduction, but your investments grow tax-free, and you won't owe any taxes when you withdraw your gains in retirement. This can be especially advantageous if you expect your tax rate to be higher during retirement.

Important Considerations

While investing in cryptocurrencies through an IRA has its benefits, there are a few things to keep in mind. First, the transaction fees associated with buying and selling cryptocurrencies can be higher than traditional investment fees, so be sure to factor that into your decision. Additionally, crypto IRAs may not offer the same level of investment diversity as a standard IRA, so you may need to consider opening multiple IRAs to achieve a well-diversified portfolio. Finally, the volatility of cryptocurrencies means that there is a higher level of risk associated with these investments, so be sure to carefully consider your risk tolerance before investing.

Move to a low-tax state/country

Moving to a low-tax state or country is an option for crypto investors to reduce their tax burden. Here are some countries with low or no taxes on crypto investments:

Malta

Malta is known for its favourable policies towards cryptocurrency and has been dubbed 'Blockchain Island'. While there is no long-term capital gains tax for cryptocurrency in Malta, trading cryptocurrency may be considered income and taxed at a maximum rate of 35%. The actual tax rate depends on various factors, including your income from crypto and your residency status. As a result, the taxes on trading income can be as low as 0-5%.

Switzerland

Switzerland is home to a hub of companies in the 'Crypto Valley'. The country does not levy capital gains tax on individual investors. Income from activities like staking and mining is subject to income tax, which ranges from 0-13.2%. Additionally, Switzerland imposes a wealth tax on assets, including crypto assets, ranging from 0.5-0.8% depending on the canton of residence.

Germany

While cryptocurrency isn't completely tax-free in Germany, the country has relatively friendly tax laws. If you hold cryptocurrency for more than 12 months before disposing of it, you won't be subject to any tax. Short-term gains of less than €600 are also exempt from taxation. However, if you earn crypto income or make profits of more than €600 from disposing of crypto within 12 months, you'll pay normal income tax rates ranging from 0-45%.

Belarus

Belarus has a unique approach to cryptocurrencies, legalising crypto activities and exempting individuals and businesses from paying taxes on capital gains and income until January 1, 2025. This exemption covers a range of crypto activities, including mining and day trading, which are considered personal investments.

El Salvador

El Salvador is the first country to accept Bitcoin as legal tender. In 2023, the country removed all taxes related to 'technological innovation', including income and capital gains tax. As a result, income and capital gains from cryptocurrencies are tax-exempt. Additionally, businesses across El Salvador are required to accept Bitcoin as payment for goods and services.

Puerto Rico

As a territory of the United States, Puerto Rico sets its own tax policies. Puerto Rico residents pay territorial income tax, which ranges from 0-33%. There is no capital gains tax for residents as long as they acquired and disposed of their crypto while residing in the territory. However, crypto acquired before moving to Puerto Rico will be subject to American capital gains tax rates.

United Arab Emirates (UAE)

The UAE does not charge income or capital gains tax for individual investors. However, goods and services, including those purchased with cryptocurrencies, are subject to a 5% VAT.

Frequently asked questions