About the author
Lewis Taub is a certified public accountant and a director of tax services at Berkowitz Pollack Brant Advisors and CPAs. He works on tax issues for businesses and individuals, and has a special focus on minimizing the tax impact of cryptocurrency transactions. He can be reached at firstname.lastname@example.org.
It’s tax season and, more than ever before, the U.S. Treasury is looking to raise revenue from crypto. That means crypto owners need to be sure to report their crypto profits to the Internal Revenue Service by the filing deadline of April 18.
No one loves paying taxes but the good news is there are strategies that crypto investors can employ to reduce what they owe. As a CPA specializing in cryptocurrency, I’ve identified five key ways to minimize your crypto tax hit.
Take Care to Identify the Dates You Acquired Any Crypto You Sold
This strategy is very effective to both reduce the profits you report to the IRS, and the tax rate you must pay on those profits.
It’s important to note that the IRS applies the same “long term” and “short term” capital gains rules to crypto as it does to stocks and other assets. These rules mean that any asset you hold for longer a year (long term) won’t be taxed any higher than 23.8%— but that those you hold for less than that that can be taxed as high as 37%.
Then there is the “specific Identification” technique. This matters when you have acquired coins over time but only sell some of them.
For example, suppose you sold some of your Bitcoin on December 1, 2021, when it was worth $58,600 per Bitcoin. If you had acquired your overall collection of Bitcoin over time—saying by buying it once a year over five different years—you could identify one or more of those purchases as the relevant price to calculate your gains. Obviously, it would be better to choose dates when your purchase price was higher since that will reduce the overall profits on which you have to pay tax (but while also keeping in mind the one-year rule for long term gains!).
A Big Tax Loophole for Crypto Losses
Under what are called “wash sale” rules, you can’t sell a stock or bond at a loss and rebuy the same stock within 30 days—that’s because the IRS doesn’t want people selling stock simply to acquire a tax deduction.
These rules only apply to “securities,” however, and not property—which is how the IRS classifies crypto. This means that, based on the current market for Bitcoin for example, you can sell at a loss and buy back the Bitcoin immediately. If you do this in 2022, the loss will be available to offset gains on cryptocurrency gains you rack up later in the year.
Note this loophole might not stay open for long. Congress has proposed several bills over the last year to close it, including one that would shut it retroactively to January 1st of this year. Gridlock in Washington D.C., means these bills did not receive a vote—but it feels only a matter of time before Congress includes cryptocurrency under the “wash sale” rules.
Avoiding or Minimizing the Tax on Airdrops
An airdrop is a form of cryptocurrency marketing in which a developer distributes new tokens to potential users and investors, often for free, to generate attention and build a loyal base of followers. Recently the IRS ruled that airdrops are taxable income if the recipient has “dominion and control” over the cryptocurrency received in the airdrop. In practice, this means that you owe tax on any airdrop in your wallet—even if you didn't ask to receive it.
The idea that receiving an airdrop can be subject to income tax rates as high as 37% can come as a surprise, especially if the recipient didn’t contribute to the crypto project in the first place.
While certain airdrops are placed directly into the investors’ wallet, others need to be claimed, typically by a specific date. The latter situation creates tax planning opportunities because until the airdrop is claimed, the investor has no “dominion and control” of the property—and no taxable income to declare. This means that, if an investor could have claimed an airdrop in 2021 and didn’t do so, they have nothing to report.
If you do plan to claim airdrops, it may be a good strategy to do it as soon as the coin in question is issued. That’s because, upon issuance, the cryptocurrency typically has little or no value because there have been minimal trades. Navigating the terms of an airdrop and the resulting tax implications can be somewhat tricky and may require a consultation with an expert familiar with the matter.
Maximize Deductions from Mining
Crypto miners are required to pay taxes on the fair market value on coins at the time they receive them. Mined cryptocurrency is taxed as income, with rates that vary between 10% - 37%. In addition, the IRS classifies mining income as “self-employment income”, and miners may be responsible for self-employment taxes on mined income. The self-employment tax rate can be as high as 15.3%, although a portion of the tax is itself a tax deduction.
The key to minimizing taxes on mining income is to make sure you claim all tax deductions against that income. These deductions can be very significant. Typically, the largest of these is the cost of computer equipment acquired solely for mining purposes. Other deductions can include electricity used for mining, as well as repair bills, supplies, and rent. If you mine in your home, a “home office” deduction may also be available.
One caveat is that the IRS may say the mining activity is not a business but rather a hobby. This could occur if the expenses exceed the income for several years and as a result, a so-called “hobby loss” could disqualify the deductions. In short, to take the deductions described above, the mining activity must be considered a business.
Keep Accurate Records
In the case of stocks, investors receive a Form 1099 from their broker that lists profits and losses. However, cryptocurrency exchanges are not required to send out Form 1099s until 2023.
This means that crypto owners looking to minimize their tax burden must take care to keep their own records. Those records should include the exact dates of purchases and sales, the amount bought and sold, and the time that the specific cryptocurrency being sold was held. Some might find it helpful to use one of the growing number of software companies that scrub the blockchain to detect transfers between wallets, and create reports of all transactions related to those wallets.
Accurate records are particularly important in the current environment because the IRS has become very vigilant over the last several years in ensuring that all cryptocurrency transactions are properly and fully reported on tax returns.