How Much Tax Do You Pay on Cryptocurrency?
Cryptocurrency is currently one of the most talked-about financial topics. Despite the fact that the market is volatile, statistics show that crypto investors profited handsomely in the early stages of the technology. Many people have made a lot of money by buying and selling virtual currencies over the last few years.
Maybe you’ve already made a purchase of cryptocurrency. If that’s the case, you’ll have to figure out when the best time is to cash in on the cryptocurrency gold rush. But, before you get there, consider how you’ll handle cryptocurrency taxes. Uncle Sam will almost certainly want a piece of the profit if you sell for a profit. While virtual currencies may not exist, the taxes you’ll have to pay do.
Naturally, you want to keep as much money as possible and maximize your gains by lowering your crypto taxes. You’ll need a basic understanding of how cryptocurrency gains are taxed to do this. Then you can start considering ways to lower or eliminate your tax bill. Hopefully, the information and advice provided below will assist you in keeping crypto taxes under control and allowing you to gain financial advantage.
What are Crypto Taxes and How Do They Affect You?
For federal income tax purposes, cryptocurrency is regarded as “property.” The IRS considers it a capital asset for the average investor. As a result, crypto taxes are the same as any other gain realised on the sale or exchange of a capital asset.
When you buy a stock, bond, house, widget, Dogecoin, Bitcoin, or other investment, you establish a basis equal to the cost of acquisition. When you sell something, you compare the proceeds to the basis to see if you made a profit or if you lost money. A capital gain occurs when the proceeds exceed your basis. A capital loss occurs if the position is reversed.
You should also think about how long you owned the asset. Your gains or losses will be classified as “short-term” or “long-term” depending on how long you keep your cryptocurrency. This distinction will have a significant impact on the amount of cryptocurrency taxes you must pay.
1. Gains and Losses on Short-Term Capital. A short-term capital gain or loss is recognised when you buy and sell an asset within a 365-day period. Short-term gains are taxed at the same rates as ordinary income, which includes wages, salaries, commissions, and other sources of earned income. In 2021, the IRS will have seven ordinary income tax brackets, ranging from 10% to 37%.
2. Gains and Losses on Long-Term Capital Assets Long-term capital gain or loss occurs when you buy an asset and sell it after a year. Because the rates are generally lower, you will pay less tax on a long-term gain than you will on a short-term gain. Long-term capital gains are currently subject to three tax rates: 0%, 15%, and 20%. Your rate is determined by your earnings.
Taxes on Cryptocurrencies: How Can They Be Minimized?
Now that you’ve learned a little more about crypto taxes, which are essentially capital gains taxes, you’ll want to devise a strategy to reduce the amount you owe the IRS. Here are a few pointers to help you save money on taxes.
1. Wait until your short-term gains have been realized before investing. Turning Short-Term Profits into Long-Term Profits
As previously stated, depending on how long you have owned cryptocurrency, different capital gains rates will apply. Hold your cryptocurrency for long enough to convert short-term gains into long-term gains if you want to reduce your tax bill. It won’t be easy, but if you have the patience and fortitude to hold onto your cryptocurrency for at least a year before selling, you’ll likely pay a lower tax rate on any capital gains.
2. Capital Gains and Losses Should Be Offset
Another way to reduce the amount of money crypto investors have to pay in taxes is to use capital losses to offset capital gains. This works by subtracting taxable gains on cryptocurrencies or other appreciated-in-value investments from losses on crypto assets sold during the year.
However, keep in mind that this strategy has its limitations. You must first offset losses of the same kind when you recognize investment losses. Short-term losses, for example, reduce your short-term gains first, followed by long-term losses. Then, if you have any net losses of either kind, you can use them to offset the other type of capital gain. So, if you have a lot of short-term losses, you can use them to offset any remaining long-term capital gain.
You can reduce your ordinary income if you still have a net capital loss. However, you can only use up to $3,000 of capital loss in any given year to reduce your ordinary income when using this strategy. The remaining balance can be carried forward to the next year to offset future gains or used to reduce your ordinary income by up to $3,000 per year.
3. Sell during a year with a low income.
When you’re waiting for your crypto gains to convert from short to long-term, another factor to consider is selling in a low-income year.
Taxes on both short- and long-term gains can be reduced by selling in a low-income year. You won’t have as much other income added on if you have short-term gains that are taxed as ordinary income. If you sell short-term assets when you retire and stop working, your tax bracket could be entirely based on the income from your short-term gains. If you have long-term capital gains, a lower overall income for the year can also translate to a lower tax rate on those gains. This is because your long-term capital gains rate either 0%, 15%, or 20% – is determined by your taxable income. As a result, if your taxable income is lower, your longer-term capital gains tax rate is likely to be lower.