3 ways savvy crypto investors use the tax code to their advantage
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It’s officially tax seasonIf you have traded any cryptocurrency during the year, it is time to file your tax returns for 2021.
These include those who bought or sold cryptocurrency and exchanged it for other cryptocurrency. It also applies to individuals who engage in other taxable events such as the earning of interest on cryptocurrency. For those who have just purchased and kept cryptocurrency, they won’t be held liable.
Although the tax bill may be unpleasant, Shehan Chandrasekera, certified public accountant, advises that it is important to accurately report income and not try to minimize it.
The calculation of taxes on cryptocurrency and nonfungible token (NFT), can be complicated, particularly if you have several wallets, trade with different exchanges, or use no software for tracking your transactions. Chandrasekera is the head of tax strategy for cryptocurrency software company CoinTracker.
He says that there are ways to “actively utilize the tax code in your favor.” This is a big incentive. He says this can help compliance be “benefit-driven”, rather than fear driven.
Chandrasekera says these are the three most important things for “savvy investors”.
1. Tax-loss harvesting
Chandrasekera suggests a strategy known as tax-loss harvesting. This is where cryptocurrency investors can sell it at a loss to offset gains.
Losses can be used as a way to reduce your stock gains, crypto gains, and regular income. You don’t have to hold onto the underwater positions. Instead, sell them and buy back.
This is because investors need to know the cost basis of their crypto currency to calculate the difference. Without a reliable software tool to track your transactions, this can prove difficult. It can save you significant tax if it is done right.
Remember that capital gains cannot be offset by the same kind of losses. Therefore, long-term loss is used to decrease long-term gains and short-term loses are used for short-term gains.
Chandrasekera explains that cryptocurrency does not fall under “wash sales rules” and “you don’t have to wait thirty days to purchase back the same position.”
Wash sale rules prohibit investors from buying the stock back immediately after they sell at a loss. Although policymakers suggested it, imposing wash sale rulesThe legislation on digital assets, currency, commodities and currencies in the Build back Better Act has been rescinded.
2. Learn the difference between short-term and long-term capital gains taxes rates
Chandrasekera states that investors should be aware of the differences between short-term and long-term capital gains taxes rates. Chandrasekera explains that long-term capital gains can be realized when investors sell assets after they have held them for more than twelve months. Short-term capital gain is when the asset is sold within less than 12 month.
He says that smart investors know about the tax benefits you get when your coins are sold after they have been held for over 12 months.
Because long-term capital gains rates are more attractive than regular income rates (which are generally the same as regular income rates but range from 10%-37%), The long-term rate can range from 0% to 15% and 20%, depending on how much you have taxable income.
Remember that you do not have to pay tax if your activities aren’t taxable.
3. Accounting method that is highest in and first out
Chandrasekera recommends that capital gains or losses be calculated using the highest-in, first-out (HIFO), accounting method.
To reduce capital gains and taxes, use HIFO to sell cryptocurrency with the highest price basis.
An investor might have bought two bitcoins last September for $4,000 and one in October for $6,000 each. He can report $6,000 on his cost basis if he sells one bitcoin for $20,000 in 2020. It would lead to fewer capital gains.
This requires meticulous record-keeping. Investors are considered responsible by the Internal Revenue Service. requires individuals to keep records “sufficient to establish the positions taken on tax returns,” according to its website.
Taxes — cryptocurrency related or not — are complicated. It can be difficult to navigate. A CPA may help.
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