The exciting thing about the crypto market is that the sentence:
“These are turbulent times for bitcoin and other cryptocurrencies”
has been true ever since the inception of bitcoin in 2009. And so whenever you are reading this article, the above sentence will most likely still be true.
The constant price changes and high volatility have led — and continue to lead to great investment opportunities, both to make and lose a lot of money. Since you need to declare gains and losses to the government and pay taxes even on Bitcoin gains, it makes sense to look at how you can reduce your personal tax burden.
This article is for you if…
- … want to get into the bitcoin and crypto scene, or
- … you already own bitcoin or other cryptocurrencies, and
- … you need to do a tax return for your crypto gains and losses, and
- … you would like to pay less taxes
1 — Check Historical Performances of Your Coins
The fundamental truth of taxation is pretty simple: You pay taxes on gains.
Gains are the difference between the amount of money that you receive when you sell your coin and the amount of money that you spent when you bought it.
Therefore, minimizing taxes is all about minimizing this difference. If you simply want to “buy” some FIAT and you are indifferent as to which coin you should sell, you can check out the price at which you bought your different assets.
You want to take $1,000 out of your portfolio but you are unsure which coin you should sell.
Imagine three months ago you bought one token for $500, which you could now sell for $1,000. You would make a gain of $500 but you’d have to pay taxes on those $500.
Now, you probably also have a token that you purchased for $1,500 a few months ago but it’s now worth only $1,000 because it has decreased in value compared to the date of purchase. If you sell this one, you still end up with $1,000 in FIAT, but you have actually “realized a loss”, with which you can offset some of your taxable gains at the end of the year and save taxes.
You should therefore always make sure to check your purchase price when considering the sale of a token.
2 — Know Your Holding Periods
You might be on crypto-cloud 9 at the moment because yet another Crypto-Bull has taken you to the skies. However, the tax authorities will eventually make it rain — for themselves.
It does always pay to know your way around a few rules and regulations that you can use to decrease your tax burden. The most important one is definitely the holding period.
A holding period is the amount of time the investment is held by an investor, or the period between the purchase and sale of a security.-Investopedia
In the US, the rules state that gains from crypto transactions that are completed within one year (i.e. buy in October, sell in May of the following year) are short term capital gains. Gains from crypto transactions, where the time between purchase and sale is 366 days or more, are long-term capital gains.
In this situation, if you wait just one more day you save a substantial amount of taxes.
In the above graph, selling just one day early would lead to significant taxes on short-term gains, while going over the magical one-year limit decreases your tax burden.
The tax rates for long-term gains are much lower than those for short-term gains. It, therefore, makes sense to always check the exact times of purchase for each transaction to minimize your taxes.
3 — Use Multiple Depots Instead of Single Depots
When calculating the gains of a sale of bitcoin or any other crypto currency, you obviously need a purchase price. This sounds very intuitive and makes sense — until you actually look at your portfolio.
What will you use to calculate the gains and losses if you bought bitcoin at different times with different prices?
What price do you use to calculate your gain/loss?
Do you just take the average price? Do you take the highest? The lowest? And what about purchasing time? As discussed above, holding periods can generate significant tax savings. But how do you measure holding periods if you have bought your currencies at different times?
There are a few inventory methods like FIFO that you can use to can minimize your tax burden somewhat, but they can really do wonders for you if you utilize multiple depots.
You probably have accounts on a few different exchanges — from Binance to Kraken to Coinbase. On those exchanges and in your wallets, all of your currencies are classifiable as distinct, individually taxable items. Therefore, you can optimize not only for “all of your bitcoin” but actually for “all of the bitcoin that you bought more than a year ago at a price of X or more”, which can greatly reduce your gains — and therefore your tax burden.
If you use multiple depots, every transaction can be viewed as creating an individually taxable item, which allows you to only pay what you have to in taxes.
4 — Keep Track of Every Transaction
One thing that you should always keep in mind when dealing with cryptocurrencies is that every transaction might have taxable consequences. You should therefore always know a few things about your portfolio:
- The total value of your portfolio
- The value of your positions
- Changes in value — both planned and unusual
- Performance indicators, strategies or anything else you want to base your purchasing decisions on
Due to the aforementioned points, it is also very important to have an overview of your performance so you won’t be surprised by taxable gains.
There are two ways to make sure you are always up to date with your portfolio. The hard way (excel and patience) and the easy way (automated portfolio tracking, i.e. by the crypto tax and portfolio tool Accointing).
5 — Use a Tax Optimizer
When thinking about taxes, you can generally do two things. One, you look at the transactions you made and try to reduce the gains that were created. Two, you preemptively make sure that your actions are already tax-optimized so you have better chances at reducing your tax burden at the end of the year.
The first method is more intuitive during the year because no one wants to think about taxes when there are bulls to catch and bears to avoid. Only when The Tax Man looms over you with his deadlines and forms does it seem more sensible to even think about taxes.
The second way is great because it makes your tax reports much easier. With just a little thought — obviously taking into consideration the first four points of this guide — you have much more influence on the end-of-year outcome.
A tax optimizer can help you in your decision-making process concerning the question which coin you should sell from your portfolio in order to minimize gains. To do this, you would need to keep in mind inventory methods such as FIFO and LIFO for multiple depots while taking into consideration the holding periods for each.
As this is very complex, you can rely on automized software solutions to make suggestions on which exact coin you should sell to minimize your gains.
The Accointing tax optimizer utilizes all of the aforementioned methods and concepts to suggest to you tax optimal transactions. As a result, you won’t have to change your strategy, you can still go chasing bulls but even if they turn out to go nowhere, you will at least have taken the tax-optimal route.
Disclaimer: This article about taxation of cryptocurrencies contains an opinion on generally worded taxation principles. They are explicitly not tax advice. As of yet, the taxation regulation is not completely unambiguous for crypto taxation. This article is not made to answer questions geared towards taxation and cannot replace an individual consultation with an accountant, attorney or bookkeeper.
Please ask your accountant before declaring your taxes.