The year is coming to an end, and a lot of people have started thinking about minimizing their tax burden. If you’re a bitcoin investor, things get even more complex. The IRS recently sent out 10,000 letters to cryptocurrency investors, and this is an indication of how serious they are when it comes to cryptocurrency tax compliance. This means that bitcoin investors need to make doubly sure that they’re filing their returns as accurately as possible. At the same time, they also need to find legitimate ways of minimizing their bitcoin taxes.
Let’s look at some things you can do to save your precious gains in April.
Tax-Loss Harvesting: Turn Your Losses Into Tax Profits
This is one of the best loopholes in current crypto regulation that you can leverage to reduce your tax burden. Let’s say you’ve made significant profits from crypto trades through the year. However, the current value of the bitcoin you hold is extremely low. You can simply sell your current bitcoin holdings at this low price. This will trigger capital losses that you can then set off against your profits. In fact, you can even use these losses to offset future gains and ordinary income (up to $3,000).
But what if you want to keep holding onto your bitcoin in the hope of future appreciation? Well, if you are based in the U.S. then you can simply buy it back afterward.
Note that some countries use Wash-Sale rules that prevent re-buying sold assets right away. For example, in Canada, a special Superficial Loss Rule kicks in whenever you sell at a loss — essentially preventing you from reducing your crypto taxes if you buy the assets back within 30 days. There is a similar rule in the U.K. as well. However, since the U.S. treats crypto as property, the Wash-Sale rule that applies to tax-loss harvesting in securities doesn’t apply to crypto.
You may have noticed that, at the time of publication, bitcoin is trading at fairly low prices, and many believe this might be because big investors are leveraging tax-loss harvesting and selling their holdings. So, if you are sitting with unrealized losses, now could be a good time to sell.
Keep Accurate Records and Avoid Costly Mistakes
One of the biggest reasons why people tend to overpay crypto tax is that they don’t have accurate records of their trades. Given that crypto investors can do hundreds of trades in a year, record-keeping can be quite a chore. This becomes more complex because exchanges don’t necessarily keep records for everyone. For instance, Coinbase only issues a tax form statement to users who have realized gains in excess of $20,000 and undertaken more than 200 transactions.
Many exchanges do allow you to download your transaction files, though, and people generally rely on these to do their bitcoin taxes. However, if you are not careful you could easily end up overpaying. Here are two of the most common mistakes that people tend to make:
Mistake #1: Treating Transfers as Taxable Events
First, there may be some transactions that are simply a transfer of cryptocurrencies from one wallet to another; but if you miss out on this, they may appear to be two separate transactions — and you will end up paying double the tax.
Let’s say you buy 1 BTC for $7,000 on Binance and later move the funds to your private BTC wallet. A few days later, you transfer the BTC from your private wallet to your Coinbase account and sell it for $7,200. So this is just one transaction, with capital gains amounting to $200. However, if you have not kept records clearly, your accountant may get confused during tax season and look at the two transactions as distinct from each other. As a result, you could end up paying taxes first on the withdrawal from Binance and again when you sell the assets on Coinbase.
Mistake #2: Not Calculating Your Cost Basis Correctly
Sometimes it becomes difficult to identify the cost of the cryptocurrency that you are selling. Without an accurate cost basis, you won’t be able to deduct the cost of acquiring an asset from the sale price. As per the IRS’s latest guidelines, you are now able to use both Specific Identification as well as FIFO (First In First Out) to calculate cost basis.
If you have records of your purchases and know the cost basis for the holdings in your different wallets, then you can make tax-efficient sales by selling coins with a high cost basis first. However, if you have no idea how much you bought the coins for, then you will just have to apply the FIFO rule which gives you no control over the cost basis and could result in higher taxes.
The Bottom Line When It Comes to Bitcoin Taxes
There’s still time to get on track before the year ends. Get your records in order and sell your holdings to leverage tax-loss harvesting — you’ll find that your end-of-season tax bill is a lot less steep than you expected. If you’re feeling overwhelmed and need expert help, consulting with a CPA who understands cryptocurrencies and bitcoin taxes might also be a good idea.
This is an op ed by Robin Singh. Views expressed are his own and do not necessarily reflect those of Bitcoin Magazine or BTC Inc. This article is for information purposes only and should not be construed as tax advice. Consult with a tax professional to assess your own individual tax requirements.
Robin Singh is the founder of Koinly - a cryptocurrency tax solution that makes it easy for crypto investors to generate their income and capital gains reports. He is also a regular contributor on the topic of crypto taxes and has written for a number of blockchain publications.