Cryptocurrency traders in the United States must navigate a complicated tax structure. They need to follow the right strategies to maximize their crypto tax deductions. This post will discuss the tax structure in the US, list the different tax brackets, and provide strategies that crypto investors in the USA can use to maximize their crypto tax deductions.
However, before considering lowering your tax bill, you need a primer on how cryptocurrency income is taxed.
Tax Structure in the USA
In the United States, the federal tax system is progressive, meaning that the more money you make, the higher the tax rate you have to pay. The tax structure is divided into seven tax brackets – 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The income thresholds for each tax bracket vary depending on your filing status, whether you are a single filer, married, filing jointly, or head of household.
Periodic income generated from activities with respect to cryptocurrency (like lending, mining, staking, etc.) is also subject to tax generally at ordinary income rates.
Furthermore, the US Internal Revenue Service (IRS) classifies income from trading cryptocurrencies as either capital gains or income, depending on how long you hold the crypto asset. If you sell an asset for more than you paid (a long-term gain or a capital gain), you are liable for capital gains tax. This tax rate is based on your filing status and the capital gain you make.
On the other hand, if you sell an asset that you held for less than a year (known as a short-term gain or an income), it is taxed as ordinary income and subject to the same tax rate as your salary.
Strategies to Maximize Crypto Tax Deductions
1. Deduct Trading Expenses
One of the most effective strategies to reduce crypto tax liabilities is deducting trading expenses. Trading expenses include any costs associated with buying and selling cryptocurrencies such as, trading fees, exchange fees, and transaction costs. You can deduct up to $3,000 from these expenses each year.
2. Take Advantage of the Tax Deferment Opportunities
The IRS allows you to defer capital gains taxes on certain investments if you reinvest the gain in a qualified investment. This is known as the 1031 exchange, and it allows you to delay paying taxes on gains from the sale of investments such as real estate, stocks, and cryptocurrencies.
3. Use Tax Loss Harvesting
Crypto tax loss harvesting is a strategy that allows you to offset capital gains taxes by selling lost value investments. The losses can offset up to $3,000 of taxable income each year. This can be a great way to reduce your tax liabilities if you have investments that have declined in value.
You should also be aware of the Wash Sale rule. According to the IRS, the rule states that "you aren't allowed to claim a tax deduction if you sell a security at a loss and replace it with the same or a substantially identical security 30 days before or after the sale." Today, the crypto wash sale rule remains a gray area. Though the rule is only applicable in stocks, crypto traders can take advantage of the rule to lower their taxes.
4. Make Charitable Donations
Making charitable donations is another way to reduce your crypto tax liabilities. Donations to qualified charities are tax-deductible and can help reduce your taxable income.
5. Invest in Cryptocurrency IRA
You can also reduce your tax liabilities by investing in a cryptocurrency IRA. Cryptocurrency IRAs allow you to invest in cryptocurrencies tax-free, meaning you do not have to pay taxes on any gains or losses. If you are below 50 years of age, you can contribute up to $6,000 per annum to all your IRAs, including self-directed IRAs.
6. Invest For The Long-term
Investing for the long term is another great strategy you can adopt to maximize crypto tax deductions. Holding your crypto portfolio for up to 12 months lets you pay less in capital gains tax.
7. Give Cryptocurrency Gifts
Offering cryptocurrencies as a gift to your friends or loved ones can also help maximize crypto tax deductions. This is so because you have no income tax obligation. If the assets you are giving out are up to $15,000 in value, you would be required to submit a gift tax return, which will be used for informational purposes only.
8. Take Out a Crypto Loan
Lastly, taking out a loan using your crypto assets as collateral can help maximize crypto tax deductions. When you take a crypto loan, you get funds to trade the market while your crypto assets remain intact until you're able to offset the loan. What's more? Crypto loans do not attract taxes.
An Example of a Long-Term Trade and its Tax Implications
Let’s take a look at an example of a long-term trade and its tax implications. Assume you bought 1 Bitcoin for $10,000 and held it for over a year. If you then sold it for $20,000, you would be liable for capital gains taxes on the $10,000 gain. The amount of tax you would pay would depend on your filing status and whether you fall into the 10%, 12%, 22%, 24%, 32%, 35%, or 37% tax bracket.
For example, if you are married and filing jointly, and your total taxable income is $50,000, you would be in the 12% tax bracket. This means you would be liable for a 12% capital gains tax on the $10,000 gain, or $1,200.
Using a Crypto Tax Calculator to File Taxes Accurately
Cryptocurrency traders can use crypto tax calculators to file their taxes accurately and on time. A crypto tax calculator is a software tool that helps you to track your cryptocurrency trades and calculate your crypto taxes. These calculators can help you to identify and claim relevant deductions, as well as to calculate gains and losses.
Furthermore, crypto tax calculators can also help you to identify and pay the correct amount of tax. This can help you to avoid costly penalties and fines from the IRS.
Cryptocurrency traders in the US must navigate a complicated tax structure and follow the right strategies to maximize their crypto tax deductions. This post has discussed the tax structure in the US, listed the different tax brackets, and provided strategies that crypto investors in the USA can use to maximize their crypto tax deductions, and provided an example of long-term trade and its tax implications. Finally, it has discussed how a crypto tax calculator can help day traders file their taxes accurately, quickly, and on time.