How to Avoid Paying Tax on Cryptocurrencies

Introduction

Taxes are payments or portion of income that is paid to the government. The government uses taxes to operate and invest in public welfare projects. Bitcoin, the first ever blockchain, was created in 2009 and it has given rise to the creation of a digital currency market.

Cryptocurrencies are an international market; therefore, every country has a different set of rules regarding taxation on their digital currencies.

For the purposes of this article, crypto taxation laws implemented by IRS are mentioned here. Investors hailing from other jurisdictions can check with their local federal taxation authority to understand cryptocurrency taxation laws in their country.

How Much Tax is Applicable on Crypto Portfolio?

Cryptocurrency investors may have to pay up to 37% for short-term capital gains and 0-20 percent on long-term digital currency trades. NFTs are also taxed at 28% rate.

IRS implements taxation rules on cryptocurrencies based on income earning, transaction types, and the duration of trading. IRS or Internal Revenue Service brought taxation laws for cryptocurrency sector in 2019 and it has continued to make changes to its taxing guidelines. The latest amendments in cryptocurrency tax laws by IRS were issued in August 2023.

Here are some instances where taxes are applied on cryptocurrency investors:

• When the cryptocurrency investor sells their holdings.
• Short-term crypto sales constituting less than a year have a higher taxation percentage on capital gains. Meanwhile, long-term positions spanning over 12 months have a smaller tax application.
• Crypto investors who have received tokens are present also have to pay taxes on their holdings when they sell them.
• IRS has imposed a maximum limit on sending cryptocurrencies as gift. Any presents above $15K requires signing for gift tax return that does not translates into current tax liability.
• Employees who receive cryptocurrencies as payments must also pay taxes in the form of income taxes. The income tax percentage on crypto depends on the amount and industry.
• Investors have to pay taxes when converting one type of digital currency into another.
• Merchants who receive cryptocurrencies as payments for goods and services must also pay taxes which is considered equivalent to selling digital currencies.

How to Save Taxes on Cryptocurrencies?

Here are some scenarios where investors do not have to pay taxes on their crypto holdings:

• Purchasing cryptocurrencies with fiat currencies. As long the investor does not sell their cryptocurrencies for cash or changes them in other tokens they do not have to pay taxes.
• Transferring cryptocurrencies among wallets or accounts that are registered under the same person.
• Donating cryptocurrencies is not taxed. Furthermore, crypto donations can also be classified as tax deductibles. Investors need a certified appraisal for crypto donations above $5000.
• Creating and minting NFTs is not subjected to taxation until they are sold.
• Investors can hire a legal consultant or tax law expert to adopt trading practices that help them avoid paying hefty taxes on their portfolio in a legal manner. However, hiring taxation consultants is expensive.  

What is the Cost Basis?

The cost basis is the total cost of acquiring cryptocurrencies including transaction and network fees. A cost basis is necessary for investors to calculate their applicable crypto taxes. Once the investor is able to determine their cost basis, they can subtract it from the value of their crypto holdings on the day of sales.

In this manner, they can find out if they have capital gains or losses and determine the taxable amount on their crypto holdings. IRS uses the following methods to determine the cost basis that result in different types of tax billing:

FIFO

FIFO stands for first in and first out meaning that the cryptocurrencies that were purchased first were also sold first.

LIFO

LIFO stands for last in and first out meaning that the assets that are last purchased and sold first.

HIFO

HIFO means highest in and first out. It means that digital currencies with the biggest cost percentage are sold first.

Spec ID

Specific identification or Spec ID is when the investors pick the assets that they sold granted that they provide corroborating records for the sales of their cryptocurrencies.

Conclusion

Crypto taxation laws are complicated and they contain many variations and provisions that are subjected to variable interpretation. Investors can make the most out of their crypto taxation filing by getting familiar with the intricacies of taxation laws.