3 Ways Smart Crypto Investors Are Using The Tax Code To Their Advantage

Although the tax bill can sting, it’s important to report accurately and not try to underestimate your income, warns accountant Shehan Chandrasekera. This applies to those who sold or spent their cryptocurrency, those who traded one cryptocurrency for another, and those who engaged in other taxable events, such as earning interest on cryptocurrency. , in 2021. Anyone who has simply purchased and held a cryptocurrency will not yet be liable.

However, there are ways to “actively use the tax code to your advantage,” he says, which can be “a huge incentive.” This can make compliance “benefit-driven” rather than fear-driven, he says.

Calculating the taxes you owe on your cryptocurrency and non-fungible token (NFT) activity can be tricky, especially if you have multiple wallets, use different exchanges, or don’t use any software to track your transactions. That’s why, “generally speaking, people are afraid of taxes,” Chandrasekera, who is also head of tax strategy at cryptocurrency software company CoinTracker, told CNBC Make It.

Here are three things “sophisticated investors do,” according to Chandrasekera.

1. Tax loss harvesting

Chandrasekera recommends a strategy called tax loss harvesting, where investors sell their cryptocurrency at a loss in order to offset their gains.

“The losses can be used to offset your crypto gains, stock gains, and even regular income. Instead of holding your underwater positions, you can sell them, buy them back and reap the losses,” he says.

Keep in mind that you can only offset capital gains with the same type of losses, so long-term losses are used to reduce long-term gains and short-term losses are used to reduce losses. short term gains.

For this to work, investors need to know how much they bought their cryptocurrency for, known as the cost basis, so they can calculate the difference. This requires careful record keeping and can be difficult without the use of a reputable software tool that tracks your transactions for tax reporting. But if done correctly, it can create significant tax savings.

The cryptocurrency isn’t subject to so-called “wash sell rules,” so “you don’t have to wait 30 days to repurchase the same position,” Chandrasekera says.

The wash sale rules prevent investors from immediately repurchasing the same shares after selling them at a loss. Although policymakers proposed to impose wash sale rules on commodities, currencies and digital assets in the Build Back Better Act, the legislation did not pass.

2. Understand the long-term and short-term capital gains tax rates

Investors should understand the difference between long-term and short-term capital gains tax rates, Chandrasekera says. Long-term capital gains are realized when an investor sells after holding an asset for at least 12 months, while short-term capital gains are realized when investments are sold in less than 12 months .

“Sophisticated investors are aware of the tax advantage you get when you sell your coins after holding them for more than 12 months,” he says.

Indeed, long-term capital gains tax rates are generally more favorable than short-term rates, which are generally the same as regular tax rates and range from 10% to 37%. Long-term rates, on the other hand, can be 0%, 15% or 20% depending on your taxable income.

3. Highest in, first out method of accounting

And remember, if you are not selling crypto or participating in any other taxable event, you are not yet liable to pay taxes.

When you use HIFO, you first sell the cryptocurrency that has the highest cost basis to reduce the amount of capital gains you have to pay tax on.

Chandrasekera also recommends using the highest accounting method, first out (HIFO) to calculate capital gains and losses.

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