Five ways to minimize your cryptocurrency tax impact

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About the author

Lewis Taub is a certified public accountant and director of tax services at Berkowitz Pollack Brant Advisors and CPAs. He deals with tax matters for companies and individuals and is particularly focused on minimizing the tax impact of cryptocurrency transactions. He can be contacted at ltaub@bpbcpa.com.

It is tax season and, more than ever, the US Treasury is looking to increase revenue from cryptocurrencies. This means that cryptocurrency owners need to be sure to report their crypto profits to the Internal Revenue Service by the April 18 filing deadline.

Nobody likes to pay taxes, but the good news is that there are strategies that cryptocurrency investors can use to reduce what they owe. As a CPA specializing in cryptocurrencies, I have identified five key ways to minimize your tax impact on cryptocurrencies.

Take care to identify the dates on which you acquired any cryptocurrency you have sold

This strategy is very effective for both reducing the profits you report to the IRS and the tax rate you have to pay on those profits.

It is important to note that the IRS applies the same rules on “long-term” and “short-term” capital gains to cryptocurrencies as well as stocks and other assets. These rules mean that any business you hold for more than a year (long-term) will not be taxed more than 23.8%, but that those you hold for less than what can be taxed up to 37%.

Then there is the “specific identification” technique. This is important when you have acquired coins over time but are only selling a few.

For example, let’s say you sold part of your Bitcoin on December 1, 2021, when it was worth $ 58,600 per Bitcoin. If you had acquired your overall Bitcoin collection over time, for example by purchasing it once a year over five different years, you could identify one or more of those purchases as the relevant price for calculating your earnings. Obviously, it would be better to choose dates when your purchase price was higher as this will reduce the overall profits you have to pay taxes on (but also keep in mind the one-year rule for long-term earnings!).

A great fiscal loophole for crypto losses

Under so-called “scrubbing sale” rules, you can’t sell a stock or bond at a loss and buy back the same stock within 30 days, this is because the IRS doesn’t want people who sell stock to simply acquire a tax deduction. .

These rules only apply to “stocks,” however, and not to ownership, which is how the IRS classifies cryptocurrencies. This means that, based on the current Bitcoin market, for example, you can sell at a loss and buy back Bitcoin immediately. If you do this in 2022, the loss will be available to offset the gains on cryptocurrency earnings you accumulate later in the year.

Note that this loophole may not stay open for long. Congress has proposed several bills over the past year to close it, including one that would close it retroactively on January 1 of this year. Gridlock in Washington DC means these bills haven’t received a vote, but it seems like only a matter of time before Congress includes cryptocurrency under the “wash-out” rules.

Avoid or minimize the tax on Airdrops

An airdrop is a form of cryptocurrency marketing in which a developer distributes new tokens to potential users and investors, often for free, to generate attention and build a loyal follower base. The IRS recently ruled that airdrops are taxable income if the recipient has “domain and control” over the cryptocurrency received in the airdrop. In practice, this means that you owe taxes on any airdrop in your wallet, even if you have not asked to receive it.

The idea that receiving an airdrop could be subject to income tax rates of up to 37% may come as a surprise, especially if the recipient didn’t contribute to the crypto project in the first place.

While some airdrops are placed directly into the investors’ wallet, others need to be claimed, typically by a specific date. The 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 didn’t, they have nothing to report.

If you are planning to request airdrops, it might be a good strategy to do so as soon as the coin in question is issued. This is because, at the time of issuance, the cryptocurrency typically has little or no value because there has been minimal trading. Exploring the terms of an airdrop and the resulting tax implications can be somewhat complicated and may require consultation with an expert who is familiar with the matter.

Maximize your mining deductions

Cryptocurrency miners are required to pay taxes on the fair market value of the coins at the time they receive them. The mined cryptocurrency is taxed as income, with rates ranging between 10% and 37%. Additionally, the IRS classifies mining income as “self-employment income” and miners may be liable for self-employment taxes on mining income. 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 make sure that you claim all tax deductions against that income. These deductions can be very significant. Typically, the largest of these is the cost of computer equipment purchased purely for mining purposes. Other deductions may include electricity used for mining, as well as bills for repairs, supplies, and rent. If you are mining in your own home, a “home office” deduction may also be available.

One caveat is that the IRS may state that mining is not a business but rather a hobby. This could occur if expenses exceed income for several years and, as a result, a so-called “hobby loss” could disqualify the deductions. In short, to take the deductions described above, mining must be considered a business.

Keep accurate records

In the case of stocks, investors receive a 1099 form from their broker listing their profit and loss. However, cryptocurrency exchanges are not required to submit 1099 forms until 2023.

This means that cryptocurrency owners looking to minimize their tax burden need to be careful about keeping their records. Such records should include the exact dates of purchases and sales, the amount bought and sold, and the time the specific cryptocurrency sold was held. Some may find it useful to use one of the growing number of blockchain scrubbing software companies to detect transfers between wallets and report all transactions related to those wallets.

Accurate records are especially important in the current environment because the IRS has become very vigilant in recent years in ensuring that all cryptocurrency transactions are correctly and completely reported on tax returns.

https://decrypt.co/94432/five-ways-to-minimize-your-crypto-tax-hit

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