Crypto Market Taking a moment to employ the right tax-reduction tactics could wind up saving you thousands on your tax bill. Cryptocurrency and digital-asset markets have seen extreme drawdowns throughout 2022. With bitcoin (BTC) alone down over 50% this year, the portfolios of many investors are in the red this year.
While investors are feeling the pain from the market downturn, it’s important to remember that crypto losses come with a silver lining: the opportunity for tax savings.
David Kemmerer is a software entrepreneur and the co-founder and CEO of cryptocurrency tax software company CoinLedger. This piece is part of Coim data cap Tax Week.
Cryptocurrencies as an asset class possess unique characteristics that make them especially good candidates for tax-loss harvesting. Let’s break down why it’s a good idea to take advantage of your crypto losses before the end of 2022.
How losses affect taxable income Crypto Market
In the U.S. and many other developed nations, capital losses fully deduct against other capital gains when they occur within the same tax year.
What does that mean?
If you will have capital gains from the sales of any capital asset in 2022 – whether that be stocks, real estate or cryptocurrencies – you can offset those gains by realizing your cryptocurrency losses. That can lead to huge tax savings.
Surprisingly, there is a lot of confusion among everyday investors with regard to this fact. Many investors don’t realize that their capital losses can deduct against an unlimited amount of capital gains.
Consider the following example: Imagine Cory sells Apple (AAPL) stock in 2022 and realizes $50,000 of capital gains in doing so. If Cory is a high earner, he could face a 37% tax on that $50,000 gain, or $18,500 owed to Uncle Sam. Ouch!
Now, let’s say Cory is also holding onto 30 NFTs that he paid a total of $35,000 for in 2022. Today, the value of those non-fungible tokens is only $1,000.
If Cory harvests, or realizes, the capital losses from his NFTs by selling them for $1,000, he would reduce his taxable income by $34,000. As a result, Cory’s NFT losses would fully deduct against his Apple stock gains.
In this scenario, Cory’s taxable gains fall to $16,000 ($50,000 minus $34,000). At a 37% tax bracket, Cory would now owe just $5,920 in taxes for his capital gains.
By strategically leveraging his capital losses, Cory reduced the amount of money he will have to pay the tax man by over $12,000.
If you have offset all of your capital gains for the year and wind up with a net capital loss, that capital loss can offset up to $3,000 of your ordinary income (like the income from your job). Any remainder can carry forward to offset gains in future years.
Tax-loss harvesting in crypto market
Tax-loss harvesting is by no means a new strategy. However, cryptocurrency’s unique properties make it well-suited for tax-loss harvesting compared to other assets.
Hyper-volatility: Because cryptocurrency is more volatile than other assets, it’s likely that investors will have multiple opportunities to harvest their losses during the tax year.
The wash sale rule: The wash sale rule states that you cannot claim a capital loss on a security if you buy the same asset within 30 days of a sale. Many tax professionals, however, take the position that because cryptocurrency is considered property by the Internal Revenue Service and not a security, it is not currently subject to the wash-sale rule.
To take full advantage of your tax-savings opportunities, you should analyze your portfolio prior to the end of 2022 to assess which assets present significant loss-harvesting opportunities. Software tools can be used to automate this process for you.
Remember, if you don’t realize or lock in your losses before Dec 31, you will lose the opportunity to reduce your taxable income for 2022.
Significant tax-savings opportunities should be on the table for the majority of crypto investors in 2022. Taking a moment to employ the right tax-reduction tactics could wind up saving you thousands on your tax bill.
You’ll be thanking yourself once the April 15 deadline rolls around.
What is CryptoCurrency ?
Cryptocurrency, also called crypto for short, is a digital payment system that doesn’t rely on banks to verify transactions. It’s a decentralized system, meaning there’s no single governing body like a government or central bank. Here are some key points about cryptocurrency:
- Digital and Encrypted: Cryptocurrencies exist only electronically, not as physical coins or bills. Encryption techniques are used to secure transactions and control the creation of new units.
- Decentralized Network: Transactions are recorded on a public ledger called a blockchain, which is a distributed database shared across a network of computers. This eliminates the need for a central authority to verify transactions.
- Medium of Exchange: Cryptocurrencies can be used to buy and sell goods or services from merchants who accept them. However, their acceptance as mainstream payment is still evolving.
- Investment Asset: Many people invest in cryptocurrencies hoping their value will increase over time. However, this is a speculative investment with a high degree of risk.
Here are some advantages and disadvantages of cryptocurrency to consider:
Advantages:
- Fast and Cheap Transactions: Crypto transactions can be faster and cheaper compared to traditional bank transfers, especially for international payments.
- Security: Blockchain technology is considered secure due to its encryption and decentralized nature.
- Transparency: All transactions on a blockchain are publicly viewable, promoting transparency.
Disadvantages:
- Volatility: Cryptocurrencies can experience significant price fluctuations, making them a risky investment.
- Regulation: The regulatory landscape surrounding cryptocurrency is still evolving, which can create uncertainty.
- Limited Adoption: Not all merchants accept cryptocurrency as payment yet.
Overall, cryptocurrency is a complex and rapidly evolving field. If you’re considering investing in cryptocurrency, it’s important to do your research and understand the risks involved.
What is Crypto Tax Crypto Market ?
Crypto tax refers to the taxes you owe on any gains or income you generate from your cryptocurrency activities. Since cryptocurrencies are considered property by tax authorities like the IRS in the US, they are treated similarly to stocks or bonds for tax purposes. This means you generally have to pay taxes when you dispose of your crypto at a profit.
Here’s a breakdown of the main scenarios that trigger crypto taxes:
- Selling Crypto for a Gain: If you sell your crypto for more than you bought it for, you’ll owe capital gains tax on the profit. The specific tax rate depends on how long you held the crypto before selling (short-term or long-term) and your taxable income bracket.
- Using Crypto to Buy Goods or Services: If you use your crypto to directly purchase goods or services, you may owe taxes on the difference between the price you paid for the crypto and the fair market value of the goods or services at the time of purchase.
- Receiving Crypto as Payment: If you receive crypto as payment for your work or services, it’s considered income and is taxed at your ordinary income tax rate.
- Mining or Staking Crypto: If you mine or stake crypto, the rewards you receive are generally considered ordinary income and taxed accordingly.
Here are some additional things to keep in mind about crypto taxes:
- Reporting Requirements: You’re generally responsible for reporting your crypto transactions on your tax return, even if you don’t receive a 1099 form from an exchange.
- Keeping Records: It’s crucial to maintain good records of your crypto transactions, including the date of purchase, sale price, fees, and any other relevant details. This will help you accurately calculate your capital gains or losses and report them correctly on your tax return.
- Tax Complexity: Crypto tax rules can be complex and vary depending on your location. Consulting with a tax professional familiar with cryptocurrency is recommended to ensure you’re compliant and minimize your tax burden.
How To Save Crypto Tax?
There are several strategies you can use to potentially reduce your crypto tax burden. Here are some key approaches:
Holding for the Long Term: In many jurisdictions, capital gains taxes are lower for assets held for more than a year (long-term) compared to those sold within a shorter timeframe (short-term). By holding your crypto for over a year before selling, you may qualify for a more favorable tax rate.
Tax-Loss Harvesting: If you have crypto investments that have decreased in value, you can sell them to generate a capital loss. This loss can then be used to offset capital gains from other crypto sales, potentially reducing your overall tax liability.
Strategic Selling: Consider planning your crypto sales around your income. If you expect to be in a lower tax bracket in a future year, you may want to hold off on selling your crypto until then.
Gifting Crypto: In some cases, gifting cryptocurrency may be a tax-efficient way to transfer it to others. However, there may be limits on the amount you can gift without triggering tax implications.
Using Crypto Tax Software: Keeping track of your crypto transactions can be complex. Crypto tax software can help you automate the process and ensure you have accurate records for tax filing.
Consulting a Tax Professional: Crypto tax regulations can be intricate and vary by location. Consulting with a tax professional familiar with cryptocurrency can help you develop a tax-efficient strategy for your specific situation.
Here are some additional points to remember:
- Record Keeping: Always maintain good records of your crypto transactions, including the date of purchase, sale price, and any fees incurred.
- Stay Updated: Crypto tax regulations are constantly evolving. Staying informed about the latest tax rules can help you make informed decisions.
Remember, these are general strategies, and it’s important to consult with a tax professional to get advice specific to your situation and location.
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