Lewis Taub is a CPA and Director of Tax Services at Berkowitz Pollack Brant Advisors and CPAs. He works on tax issues for businesses and individuals, and particularly focuses on minimizing the tax impact of cryptocurrency transactions. He can be reached at [email protected]
It’s tax season, and more than ever, the US Treasury is looking to boost crypto revenue. This means crypto owners should make sure to report their crypto profits to the Internal Revenue Service before the April 18 filing deadline.
Nobody likes paying taxes, but the good news is that there are strategies crypto investors can use to reduce what they owe. As a CPA specializing in cryptocurrency, I have identified five key ways to minimize your tax impact on crypto.
Take care to identify the dates you acquired any crypto you sold
This strategy is very effective in reducing both the profits you report to the IRS and the tax rate you must pay on those profits.
Importantly, the IRS applies the same “long-term” and “short-term” capital gains rules to crypto as it does to stocks and other assets. These rules mean that any assets you hold for more than a year (long-term) will not be taxed at more than 23.8%, but those you hold for less can be taxed at up to 37%.
Then there is the technique of “specific identification”. This is important when you have acquired parts over time but only sell some of them.
For example, suppose you sold some of your Bitcoin on December 1, 2021, when it was worth $58,600 per Bitcoin. If you had acquired your overall collection of Bitcoin over time, i.e. by buying it once a year over five different years, you could identify one or more of these purchases as the relevant price to calculate your earnings. . Obviously it would be better to choose dates where your purchase price was higher as this will reduce the overall profits you have to pay tax on (but bearing in mind the one year rule for gains at long term !).
A Big Tax Loophole for Crypto Losses
Under what’s called the “wash sale” rules, you can’t sell a stock or bond at a loss and buy back the same stock within 30 days, because the IRS doesn’t want people selling stocks simply get a tax deduction.
However, these rules only apply to “securities,” not property, which is how the IRS classifies crypto. This means that, based on the current Bitcoin market for example, you can sell at a loss and buy Bitcoin back immediately. If you do so in 2022, the loss will be available to offset gains on cryptocurrency gains you accrue later in the year.
Note that this loophole might not stay open for long. Congress has proposed several bills over the past year to shut it down, including one that would shut it down retroactively to January 1 of this year. The Washington DC gridlock means those bills haven’t passed, but it only seems a matter of time before Congress includes cryptocurrency in the “wash sale” rules.
Avoid or minimize airdrop tax
An airdrop is a form of cryptocurrency marketing in which a developer distributes new tokens to potential users and investors, often for free, to gain attention and build a loyal follower base. Recently, the IRS ruled that airdrops are taxable income if the recipient has “dominion and control” over the cryptocurrency received in the airdrop. In practice, this means you owe tax on any airdrop in your wallet, even if you didn’t request to receive it.
The idea that receiving an airdrop can be subject to tax rates of up to 37% may come as a surprise, especially if the recipient did not contribute to the crypto project in the first place.
While some airdrops are placed directly into investors’ wallets, others must be claimed, usually on a specific date. This latter situation creates opportunities for tax planning, because until the airdrop is claimed, the investor has no “dominion and control” over the property and no taxable income to report. This means that, if an investor could have claimed an airdrop in 2021 and did not, they have nothing to report.
If you plan to claim airdrops, it may be a good idea to do so as soon as the coin in question is issued. This is because when issued, cryptocurrency usually has little or no value because there has been little trading. Navigating the terms of an airdrop and the resulting tax implications can be somewhat tricky and may require consultation with an expert familiar with the subject.
Maximize Mining Deductions
Crypto miners are required to pay taxes on the fair market value of the coins when they receive them. Mined cryptocurrency is taxed as income, with rates varying between 10% and 37%. Additionally, the IRS categorizes mining income as “self-employment income,” and miners may be liable for mining income taxes. The self-employment tax rate can be as high as 15.3%, although part of the tax is itself a tax deduction.
The key to minimizing taxes on mining income is to ensure that you claim all tax deductions on that income. These deductions can be very significant. Typically, the most significant of these is the cost of computer hardware acquired solely for mining purposes. Other deductions may include electricity used for mining, as well as repair bills, supplies, and rent. If you operate mines from your home, a “home office” deduction may also be available.
One caveat is that the IRS may say that mining is not a business but rather a hobby. This could happen if expenses exceed income for several years and therefore a so-called “loss of hobby” could disqualify deductions. In short, to benefit from the deductions described above, the mining activity must be considered a business.
Keep accurate records
In the case of stocks, investors receive a Form 1099 from their broker that lists profits and losses. However, cryptocurrency exchanges are not required to submit 1099 forms until 2023.
This means that crypto owners looking to minimize their tax burden should be careful to keep their own records. These records should include the exact dates of purchases and sales, the amount bought and sold, and the time the specific cryptocurrency being sold was held. Some might find it useful to use one of the many software companies that cleans the blockchain to detect transfers between wallets and create reports on all transactions related to these wallets.
Accurate records are especially important in today’s environment, as the IRS has become very vigilant over the past few years to ensure that all cryptocurrency transactions are correctly and fully reported on tax returns.