Taxes are a necessary evil and capital gains taxes are no exception. Capital gains taxes are required across all purchases when money is profited after investing in any asset. These taxes can turn out a hefty sum, depending on when you gained these profits and how much profit was made.
While it can seem unfair to pay taxes after a job well done investing, a few methods exist to avoid or reduce these excessive capital gain taxes. Where you place your investment and when and how you sell it can reduce your total owed dues.
What Are Capital Gains Taxes?
Capital gains taxes are profit taxes on non-inventory assets. People pay income taxes on their taxable income, so capital gains taxes target investors who make money by buying and selling assets. Common capital asset purchases include stocks, precious metals, real estate, bonds, and cryptocurrency.
Capital gains taxes aren’t immediately withdrawn, like state and federal taxes. Instead, the profits must be reported the following year on your tax return. At that time, you’ll receive a notice indicating the percentage of taxes that will need to be paid.
How Do Cryptocurrency Taxes Work?
Cryptocurrencies are decentralized digital currencies not issued by the federal government. Investors buy and sell cryptos to gain profits from the value fluctuations. The IRS views cryptocurrencies as capital assets that result in tax events when sold.
Because crypto values fluctuate frequently, the government charges taxes based on the asset’s sale price at the profit realization time. The profit realization time is when you exchange or sell the cryptocurrency to make money.
For example, if you sold Bitcoin, a popular digital currency, for a $10,000 profit several months ago. If you were to sell the same amount of Bitcoin today, you would net a $30,000 profit. The profit realization time indicated when personal cryptos were sold and for how much.
Regardless of how much Bitcoin would be worth at the time of taxes, the profit realization makes it so that you’re only paying taxes on your profit of $10,000. The amount of time you owned the asset directly determines the percentage of capital gains taxes owed.
Long-term Capital Gains
Long-term gains include any asset you own for more than a year before profiting. You enjoy significantly reduced tax rates when you hold onto an item for an extended period before selling. The taxes on long-term capital gains come in three different tax brackets, depending on your filing status and annual income:
- 0% rate: Single person making up to $41,675, head of household making up to $55,800, jointly filing married couple making up to $83,350, or married filing separately making up to $41,675
- 15% rate: Single person making up to $459,750, head of household making up to $488,500, jointly filing married couple making up to $517,200, or married filing separately making up to $258,600
- 20% rate: Single person making over $459,750, head of household making over $488,500, jointly filing married couple making over $517,200, or married filing separately making over $258,600
Because long-term gains offer these decreased rates, we usually recommend you hold on to your investment for at least one year to cut down your owed taxes.
Short-term Capital Gains
Short-term capital gains include any investment you sell in less than a year of owning. Short-term investments receive the harshest tax rates. These tax rates coincide with the annual filing tax percentages that the government uses to withhold federal tax yearly.
When considering these gains as part of your regular income, they fall within one of seven U.S. federal tax bracket categories, including:
The above rates depend on your household status and income, just as they do for long-term gains. Since short-term gains are considered income, they usually bump up your tax bracket and cause you to pay a higher income tax rate. For example, if you typically make under $50,000 (placing you in the 22% tax bracket) but make another $50,000 in investments, you’ll pay 24% in taxes since the government sees your annual income as $100,000.
Given the ranges above, you can determine the amount you pay for short-term capital gains tax is much more than long-term, regardless of your salary and marital status.
How Is Cryptocurrency Taxed?
Understanding how taxes work on cryptocurrency is more challenging than other investments since the rates fluctuate frequently, and no physical asset represents the investment. The government tracks cryptocurrency transactions based on taxable and nontaxable events.
Taxable cryptocurrency events include:
- Exchanging crypto for standard government currency (fiat money)
- Buying any goods, investments, or services with crypto
- Exchanging one crypto for another (they all offer different value rates)
- Receiving crypto (mined or forked) as a gift, payment, reward, etc.
Nontaxable cryptocurrency events include:
- Using fiat money to purchase crypto
- Donating crypto to any tax-exempt charity or non-profit organization
- Sending a cryptocurrency gift to another party (some exclusions apply)
- Transferring the same crypto between wallets
Purchasing cryptocurrency is similar to investing in any other asset. There is no tax penalty when you buy crypto. Taxes are only paid when your investments are sold.
So long as your activity with crypto was purchasing it, nothing needs to be reported to the IRS.
Selling cryptocurrency and cashing it out for fiat money requires that you learn your coin’s cost basis. The cost basis refers to the total money you paid plus all fees.
When you’re ready to trade your crypto in for cash, you will subtract the cost basis from the current market value of the digital currency. For example, if you purchased the crypto for $10,000 and paid $1,000 in fees, though it’s now worth $30,000, your total gains equal $19,000 because $30,000 – $11,000 = $19,000.
The remaining amount (if there is any) is your capital gain. If your investment decreases in value, it’s a capital loss. Regardless, you’ll end up with a capital gain or loss taxable event.
Paying for Purchases with Crypto
As cryptocurrency becomes more popular, many in-person and online sellers are beginning to accept crypto as a valid payment option. You can buy anything from a car to antique art with popular cryptocurrencies, like Bitcoin. Unfortunately, this convenience results in double tax rates since — sales and capital gains taxes.
Sales tax will be added when you transfer the crypto from your wallet to the seller. If your crypto’s value increases after the sale, you must pay for the capital gain on the taxable event. If the crypto loses value, you must manage the capital loss deduction.
We recommend diligently tracking crypto values at purchase times to keep track of the above information.
Advanced investors often trade different cryptocurrencies for one another as values fluctuate. Usually, you use your current crypto rather than fiat money to purchase the new cryptocurrency. Essentially, this transaction places you in the same situation as buying anything else with crypto: You must report and pay taxes on any capital gains or losses from your investment.
We recommend using an exchange service to keep your information organized when trading between different cryptos. You must manage how much you’re spending, purchase rates, and current market values to ensure that you pay all taxes correctly.
10 Ways to Avoid Capital Gains Taxes on Crypto
Whether you’re an investing shark or someone just trying to save for retirement, you likely want to pay as little taxes as possible. Luckily, U.S. tax laws have quite a few legal loopholes that allow you to save money when you practice proper planning. You can combine several strategies and save money by changing how you purchase, store, and claim the investment when you sell it.
Many people don’t realize they can avoid taxes by making some simple adjustments to their investment strategies. We recommend picking an option that fits your financial goals to reduce taxes without compromising your personal needs. If you want to avoid biting the bullet on huge owed taxes to the government, try one or more of the options below.
1. Buy Crypto in an IRA
Individual retirement accounts (IRAs) are self-directed savings accounts that offer tax advantages since they’re locked away until retirement age. You can place fiat money into your IRA, though many organizations allow you to directly invest in stocks, gold, crypto, and other assets through the IRA.
After an account is set up with a provider, taxes will still have to be paid, though the rates won’t be as high. The amount you pay directly relates to your filing status and income. There also have a couple of options to choose between when opening a crypto IRA:
- Traditional: Traditional IRAs allow you to contribute non-taxed funds, though standard income taxes must be paid whenever money is withdrawn during retirement.
- Roth: Roth IRAs require contributions to be made with post-tax money, allowing you to withdraw funds during retirement without worrying about taxes.
2. Claim Crypto as Income
Whenever you receive cryptocurrency in exchange for your services or products, you must pay income taxes on it as any worker would. Income taxes also apply for mining crypto. When you report the income on your tax return, you count the crypto as its market value when it was received.
Capital gains taxes must be paid on any increased value when you sell and profit from the cryptocurrency. For example, if someone paid you $5,000 in crypto, you would report this as income. In a few years, if you sell that currency for $8,000, you must pay capital gains tax on the $3,000 profit.
Claiming crypto as income might not be the best way to avoid paying taxes, though sometimes you can’t get around it. We recommend not accepting cryptocurrency as payment for your goods or services or converting it to fiat money immediately, so it maintains the same value if you want to avoid extra taxes.
3. Hold Onto Crypto
Avoid taxes on crypto by doing nothing with it. You only have to pay the government during tax events. If you leave your cryptocurrency where it is and don’t sell, buy, or trade with it, nothing will need to be paid. We recommend leaving your crypto in an account, preferably an IRA, until you’re ready to pay the associated fees.
If you buy and sell multiple times, taxes will have to be paid repeatedly, which wastes money. Try to hold onto your crypto for a minimum of one year to avoid the short-term capital gains tax, though the longer you hold onto it, the better.
4. Buy Crypto in Your Life Insurance Policy
International life insurance policies might be challenging to create, but they allow you to save most of your funds. You will need to select an Offshore Private Placement Life Insurance organization and fund it with your crypto (or any other asset). The account works similarly to a Roth or Traditional IRA, though you won’t have to deal with any contribution limitations.
Note that many organizations require minimum contributions instead of limiting your maximum contribution. For example, you may need to fund an initial investment of at least $1.5 to $2.5 million worth of crypto. If you can’t afford such numbers, we recommend sticking with an IRA instead.
With IRAs and life insurance policies, you must pay taxes when you withdraw the funds; however, if you keep the crypto in your account until your death, your beneficiaries can receive it tax-free. If you want to bequeath money to your future family and pay zero taxes, consider storing your crypto in a life insurance policy.
5. Buy Crypto as a Puerto Rico Resident
United States residents must pay taxes on any global income, regardless of where they made it. The only exception is Puerto Rico, a U.S. territory offering incredible tax benefits, including zero capital gains tax requirements. To become a legal resident and enjoy this perk, you must live on the island for at least 183 days and buy a house within two years.
Moving your life to a new place to avoid taxes might sound far too challenging, and it is for most. We usually only recommend this strategy to investors with millions of dollars on the line. If you can qualify for Act 22 (residency requirements), you won’t have to pay for short- or long-term gains.
Remember that if you move back to the United States, your funds will become taxable again. We recommend discussing this option with an expert before beginning the process.
6. Offset Your Crypto Gains with Crypto Losses
You’ll either profit or lose money when you sell your crypto, depending on how the value fluctuates after it’s purchased. Gains and losses each come with different tax requirements, though they can offset each other when the values are balanced. Tax-loss harvesting is the term for using offsetting to your advantage.
When using this strategy, note that you must first offset short-term gains against short-term losses and long-term with long-term. After offsetting your short- and long-term losses individually, you can compensate a net short-term gain against a net long-term loss (or vice-versa) to reduce taxes as much as possible.
For example, if you made $4,000 in short-term gains and lost $2,000, along with $6,000 in long-term gains and $9,000 in losses. Using these figures, you would have a net short-term gain of $2,000 and a long-term loss of $3,000. Once netted together, you have a $1,000 loss.
You can claim a maximum of $3,000 of capital losses each year, and any leftovers can roll over to the future. If numbers aren’t your forte, we recommend seeking professional help to pull off this strategy.
7. Donate to Charity
Many major charity organizations offer tax-deductible donations allowing you to itemize your deductions on the next tax return and save on fees. To qualify for this advantage, you must keep your cryptocurrency for at least a year before donating. When you’re ready to file taxes, you can deduct the market value of your crypto without paying capital gains tax.
It’s important to note that tax-deductible donations usually have maximum limitations, and only specific charities offer this benefit. Always conduct research before planning your financial strategy.
8. Sell During Low-income Years
Whether you pay short- or long-term rates, your tax percentage will always depend on your income. The higher your annual salary, the more taxes will be paid. If you want a lower capital gains tax rate, wait for a lower income year to enjoy reduced taxes.
We don’t recommend quitting your job just to reduce your tax bracket, as you would likely lose more than you’d gain.
9. Give Crypto as Gifts to Family
When crypto is given as gifts to a family member, taxes on the exchange don’t have to be paid. You can give up to $15,000 worth of assets without being required to pay taxes. Above this number, you will need to pay taxes until you reach the $11.7 million lifetime cap.
If your recipient decides to sell the crypto, they become responsible for paying taxes on the gains or losses.
10. Apply the Crypto Wash Sale Rule
The IRS created the wash sale rule to prevent investors from intentionally selling and instantly re-purchasing security investments to harvest tax losses. Securities include stocks, mutual funds, bonds, exchange-traded funds, futures, and stock warrants, but not cryptocurrency. Because the wash sale rule doesn’t yet apply to most cryptos, you can sell at a loss and re-purchase without waiting.
Crypto stocks are exempt from the Crypto Wash Sale rule. You must wait 30 days to re-purchase crypto stock in an exchange since the government categorizes the asset as a security. Select non-security assets, like cryptocurrency, instead of stocks if you want to take advantage of this tax-harvesting tactic.
Avoid Taxes by Opening a Crypto IRA with My Digital Money Today!
Avoiding capital gains tax on cryptocurrency gains is challenging, though often worth it for most investors. One of the easiest ways to reduce tax fees is by keeping your crypto in an IRA. At My Digital Money, we offer tax-advantaged retirement accounts for cryptocurrencies so you can securely trade while decreasing the taxes you owe to the government.
Our active trading platform offers many convenient features so you can maintain control over your investment. The Stop-Loss and Auto-Order features let you automatically buy and sell whenever different cryptos reach your preferred market values. Our IRAs, active trading, and Play Money accounts each include military-grade security via Genesis, U.S.
When you’re ready to avoid capital gains tax, open an account with My Digital Money by signing up online or calling our team at (833) 636-2008 for more information!