As the end of the year approaches, there are still ways to reduce cryptocurrency tax bills, financial experts say.
The IRS generally defines cryptocurrency as property for tax purposes, and investors must pay levies on the difference between the purchase and sales price.
If there’s a profit on assets held for less than one year, it’s a short-term gain, subject to regular marginal tax rates from 10% to 37% for 2021.
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And currency owned for more than one year may qualify for lower long-term capital gains rates of 0%, 15% or 20%, depending on income.
While buying currency isn’t a taxable event, someone may owe levies by converting it to cash or another coin, using it to pay for goods and services, receiving payment for work and more.
1. Tracking gains
One of the biggest challenges for cryptocurrency investors is tracking gains and losses, said Shehan Chandrasekera, a CPA and head of tax strategy at crypto tax software company CoinTracker.io.
That’s because many exchanges won’t send Form 1099-B detailing annual proceeds, forcing investors to calculate annual profits or losses on their own.
And it’s normal for investors to have multiple wallets across different exchanges, he said, further adding to reporting challenges. But investors still must disclose their taxable transactions.
“You as a taxpayer are responsible for reporting all of your income, whether there are tax documents for it or not,” said enrolled agent Adam Markowitz, vice president at Howard L Markowitz PA, CPA in Leesburg, Florida.
“The problem people are the ones who buy a piece of bitcoin every time they get paid and then turn around and convert that bitcoin 72 times to different things,” he said.
The best way for high-volume traders to get organized may be investing in tracking software, including versions from previous years, depending on their activity, Markowitz said.
While there may be discrepancies, the software may offer an estimate of yearly gains or losses since “99.9% of cryptocurrency users have zero clue,” he said.
If someone expects taxable gains for 2021, they may take advantage of a loophole allowing them to offset some profits with losses.
Currently, digital assets are not subject to the so-called “wash-sale rule,” stopping someone from selling a losing investment to write-off the loss against other gains and keeping their exposure by rebuying a “substantially identical” asset within 30 days.
“If the market is down, it’s a good time to harvest those losses,” Chandrasekera said, and some investors have already been watching for opportunities.
For example, if someone bought bitcoin at $60,000, they may take advantage of the loophole by selling if it drops to $50,000, use the $10,000 loss to offset other gains, and repurchase the asset shortly after.
“You can sell losing positions now and buy them right back in three seconds,” Markowitz added.
However, House Democrats want to close this loophole after Dec. 31, 2021, requiring digital currency to follow the same wash-sale guidelines as stocks, bonds and other securities.
And if someone wants to diversify their regular taxable portfolio, they may use the current crypto wash-sale loophole for the same purpose.
“Maybe you take more [cryptocurrency] losses this year and get back into the market,” said Dan Herron, a San Luis Obispo, California-based certified financial planner and CPA with Elemental Wealth Advisors. “You can use that to your fullest advantage right now.”
3. Leverage lower brackets
Another tax strategy may be selling appreciated digital currency if someone expects to pay higher levies in the future, Herron said, and some investors may qualify for a 0% tax rate.
A married couple filing together with a taxable income of $80,800 or less ($40,400 for single filers) may pay 0% long-term capital gains levies for 2021 after subtracting a $25,100 standard deduction from their adjusted gross income.
Someone under the threshold may also sell cryptocurrency at a profit, pay no long-term capital gains and rebuy the asset for a so-called “step-up in basis,” which adjusts the purchase price to the current value for a lower tax bill in the future.
“I think that is probably an underused strategy,” Markowitz said.
While relying on a tax professional to reconcile hundreds or thousands of crypto transactions may lead to a costly bill, investors may save money by using tracking software to generate reports before meeting with an advisor, Herron said.
However, someone with five, six or seven figures’ worth of cryptocurrency may benefit from ongoing tax planning, not just year-end advice, Markowitz said.
“You are missing out on potentially enormous opportunities in a market that never closes,” he said.
And like all types of financial planning, the better information investors provide, the more beneficial advice they may receive.
“It always boils down to communication with your tax preparer,” said Markowitz. “And making sure you have somebody who knows what they’re doing.”