How To Not Pay Taxes On Bitcoin

Many investors view cryptocurrency as a viable investment option, but they may not be aware of the taxes they are required to pay on their gains.

Although cryptocurrencies are a relatively new asset class that has created a great deal of wealth for early investors, it’s important to remember: whenever wealth is created, it is likely to be taxed.

The IRS sees cryptocurrency as a digital asset, or property. So any time you use crypto to buy and sell goods.

Fortunately, the US tax code includes some ways for crypto investors to reduce their crypto tax burden.

Here’s a quick recap of how crypto tax works as well as 12 ways to help you legally avoid taxes on cryptocurrency.

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How Cryptocurrency Taxes Work

Most people hold cryptocurrency as an investment. You owe taxes on your income worldwide if you are a United States citizen.

This means you will have to pay capital gains taxes on it. (Cryptocurrencies may also be taxable as income, which we will discuss in more detail later.)

When you sell digital currencies for more than you purchased them and held the cryptocurrency investment for a year or less, it is regarded as a short-term capital gain.

There are two types of capital gains taxes: short-term and long-term capital gains, depending on how long you hold the asset, in this case, cryptocurrency.

Taxed at the same rate as wage income, this taxable event can be costly.

Conversely, when you sell cryptocurrency for more than it was bought and held for longer than one year, it results in a long-term capital gain that has more favorable tax rates that can be as low as 0%.

Despite its recent presence in the market, Congress and the IRS may decide to change their stance on crypto taxes in the future.

To ensure that your potential tax obligations are limited or eliminated altogether, here are some strategies you could consider.

12 Ways to Avoid Taxes on Bitcoin

Here are 12 ways to legally avoid crypto tax:

1. Buy Your Crypto in an IRA

Cryptocurrencies can be purchased in a self-directed IRA in a tax-advantaged manner depending on your retirement plan.

It is a retirement account that allows you to trade precious metals, real estate, and crypto assets on your own.

In order to invest in a cryptocurrency of your choice, you need to locate a self-directed IRA that allows you to do so. Before you proceed, make sure you understand how to invest in a cryptocurrency in a self-directed IRA.

Depending on your tax situation and the type of IRA you open and contribute to, you will receive different tax benefits once your account is set up.

A traditional IRA allows for tax-deductible contributions, but withdrawals in retirement are subject to ordinary income tax.

Roth IRAs require that you contribute post-tax money, but they allow you to withdraw funds in retirement tax-free as long as you meet the requirements.

2. Declare Crypto Income

In the case of receiving digital coins in exchange for goods and services or mining cryptocurrency, taxation differs.

Whenever you receive a cryptocurrency, it will be treated as income. To file your taxes correctly, you must record and report the fair market value of the cryptocurrency you received.

The income is taxed at ordinary income taxes, which are higher than capital gains taxes.

As a result of receiving cryptocurrency, you report the amount you received as income as your basis, a term used to describe the currency’s value at the time you received it.

When you finally dispose of the cryptocurrency, you use that basis to calculate any capital gains you may have and pay capital gains taxes based on that basis.

In addition to ordinary income taxes, you may also have to add self-employment taxes to your crypto tax bill.

3. Relocate to Puerto Rico

If you have substantial digital asset wealth, moving to Puerto Rico might help you avoid some US federal income tax.

Puerto Rico is a US territory with unique tax benefits, including a 100% exemption on capital gains.

Therefore, relocating to Puerto Rico could save you a significant sum on your tax bill, whether it’s saving on crypto or avoiding capital gains on stocks.

To qualify to file your taxes in Puerto Rico, you must become a bona fide resident and maintain that residency for the past two years.

If you do not establish bona fide residency in Puerto Rico prior to moving, any gains from your cryptocurrency are still taxable in the United States.

Note: You should consult a tax advisor before considering this strategy because it is extremely complex.

4. Offset Capital Gains with Losses

Whether you realize a gain or loss when you sell an investment depends on how much you sold it for and what its cost basis was.

A benefit of the US tax code is that capital gains and losses can be offset. You can harvest tax losses if you use this consciously.

Gains and losses of the same type offset each other first. For tax purposes, short-term crypto gains offset short-term losses.

Then, any net loss may be offset against a gain of another type.

Suppose you have a $1,000 short-term loss, a $2,000 short-term gain, a $3,000 long-term gain, and a $5,000 long-term loss. In this case, you’d end up with a $1,000 net short-term gain and a $2,000 net long-term loss.

To get a net long-term loss of $1,000, you would net these values against each other.

Many robo-advisors and crypto tax software offer automatic tax loss harvesting for investors if they have an overall capital loss for the year. You can claim up to $3,000 of that loss.

Any leftover loss can be carried forward.

5. Invest for the Long Term

You can avoid taxes altogether by not selling any cryptocurrency during a tax year as long as you hold it as an investment and it isn’t earning any income.

It may eventually be necessary to sell your cryptocurrency, though.

6. Make a Charitable Donation

If you make a donation to a charity and the charity qualifies as a tax-exempt 501(c)(3) charity, you won’t have to pay capital gains tax.

To determine how much you can deduct from your taxes, consult a tax professional.

7. During a Low-Income Year, Sell Assets

In order to determine your tax rate, you need to know your income. The lower your taxable income, the lower your tax rate.

You might save money on taxes by selling cryptocurrency that you know will experience gains in years when you know you’ll pay lower taxes.

Some of the income you get from selling cryptocurrency might be taxed at a higher rate, but it won’t push all of it into a higher tax bracket.

8. Family Gifts

You will have to pay tax on the entire gain over your basis, but the tax may be less than if you paid it yourself when you sold the cryptocurrency.

As an example, an adult in their 50s with a lucrative career is likely to have a higher tax bracket than a recent college graduate trying to get their first job.

Therefore, if you gift your crypto to a younger relative, you may have a lower tax liability.

9. Keep Your Crypto Until You Die

A cryptocurrency can be used as a generational wealth-building tool if you believe in the long-term value of the investment, but this strategy might provide you with outstanding tax benefits.

Upon your death, your assets are passed on to your heirs on a step-up basis.

The basis of the Bitcoin increases to $250,000 if you die and pass it on to your heirs.

As a result, your heirs can sell the asset immediately for its U.S. dollar value without paying any income tax on the asset, since their basis is equal to the price they sell it for.

A financial professional who specializes in estate planning can help you arrange this type of inheritance properly.

10. Hire a CPA Who Specializes in Crypto

Understanding the US tax code on your own can be challenging, which is why you can hire a crypto-specialized CPA (Certified Public Accountant).

It may be expensive but if you have a lot of interest in crypto, it is worth your time and money. An accountant who is well-versed in crypto can identify strategies to legally minimize your crypto tax burden and in the process cover their own costs.

11. Take Out a Crypto Loan

If you want to use your crypto profits without paying tax on them, consider taking out a crypto loan and using your crypto as collateral.

Taking out a crypto loan is a non-taxable event, unlike selling your crypto. Depending on your personal income bracket and the loan’s interest rate, you may be able to actually save money.

12. Use Crypto Tax Software

If you’re looking for a way to save money and time when filing taxes, consider using crypto tax software. You can automatically import your crypto transactions from exchanges like Coinbase and generate a detailed tax report.

Once your report is ready and accurate you can plug it into your tax filings software like TaxAct or TurboTax.

Read more: Best Tax Software

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