When cryptocurrency investing first became popular, hardly anyone paid taxes on profits. However, as the market became more regulated, authorities tightened taxation. Let’s dig into cryptocurrency investment and taxation together and discover ways to optimize your crypto taxes.
A unique feature of investing and trading cryptocurrency is that cryptocurrency is a cross between an asset (for example, stocks) and currency (for example, the US dollar). An analysis of the basics of cryptocurrency is very different from an analysis of any other financial asset. Traditional methods of measuring value do not work in the crypto industry, mainly because in many cases cryptographic data is not stored anywhere in a central hub. In fact, most cryptocurrencies and their blockchains are decentralized, which means that no central authority is responsible for it. Instead, power is distributed among members of any given blockchain community or crypto community.
In most countries, including the United States, you have to pay capital gains taxes on your cryptocurrency activities. The US Internal Revenue Service considers Bitcoin and other cryptocurrencies as property; consequently, crypto transactions are taxed on capital gains. There is still the possibility that authorities can make adverse changes to tax laws, such as limiting deductions, raising tax rates, and eliminating tax benefits.
The best approach to earn profit in the crypto market is to optimize crypto trading, find means to minimize taxes, and exclude risks associated with investing in digital assets. Let’s consider these steps in detail.
Optimization of Your Trading Activity
Reporting on your crypto-income and capital gains can be a complicated process. You have to keep track of all your taxable events. Every time you sell or exchange your crypto assets for another crypto or for goods/services, you trigger a taxable event. Furthermore, if you trade across multiple exchanges, this complicates tracking and reporting.
There are a lot of things to keep in mind when evaluating your crypto activities. For instance, hard forks. The IRS has clearly stated that hard forks and airdrops can be taxable. For example, if you have Ethereum and it undergoes a hard fork that pays you an equal amount of a new cryptocurrency, in addition to your initial Ethereum assets, you have to pay regular taxes on new free coins as opposed to a capital gains tax in the long run. You pay these taxes based on the value of the new cryptocurrency on the day you receive it. The IRS issued recommendations regarding taxation of hard forks. Be sure to consult a tax specialist and stay ahead of the game by tracking all of your crypto records.
Reporting International Cryptocurrencies
The cryptocurrency market and its rules are constantly evolving. That is why you should be aware of all your cryptocurrencies. But even if you invest in cryptocurrencies outside the US, you must report it to the IRS.
If you reside in the United States, you may need to file a FBAR for crypto if you ever exceed the amount of $10,000 that is held in foreign cryptocurrency exchange accounts at any time of the calendar year. Make sure you are aware of the crypto trading rules of the IRS as they can change. Be sure to consult a tax specialist.
Note: Remember that you are responsible for knowing the tax consequences of your cryptographic activities. The IRS is pursuing cryptocurrency investments inside and outside the US. This even forced Coinbase to flip the records of its customers in 2017. Thus, people who simply did not know they had to pay taxes got into trouble just like those who tried to hide their crypto investments.
Cryptocurrency taxation is still a fuzzy area. Most regulators cannot even agree on the basic concept of what the token represents. And, of course, different countries have different rules. That is why it is extremely important to conduct a comprehensive tax audit before developing an investment strategy. After receiving information about the risks, you will be at the top of your game. Knowing your risk tolerance, you can create a strategy that protects you and your wealth.
Use a Crypto Tax Tool
One of the greatest ways to save on your taxes on cryptocurrency investments is to include the entire history of trading in crypto tax software. Such programs have built-in tools to analyze and optimize gains and losses reports to enable you to find ways to minimize taxes. You can easily import your trading archives by connecting your cryptocurrency exchange accounts. Once your history of transactions is uploaded, the tool will analyze it, calculate gains and losses, and provide a tax report with one click.
Open a Crypto 401(k) or IRA Retirement Account
Utilizing a retirement account such as IRA to buy crypto, you can achieve the deferment of taxes(sometimes you may not pay at all). This contradicts the use of the traditional cryptocurrency exchange when the income received from the sale or trade of cryptocurrencies is taxed for the same year. IRA appears to be an efficient tool to reduce taxes, and it will be even more useful when crypto will become a more stable long-term value asset.
Look for a Threshold
Many countries provide an opportunity to make duty free investments, often in the form of a capital gains threshold. If you don’t cross that threshold, you will not have to pay taxes. Countries also offer specially designed investment banks that are not taxed or have certain conditions, and meeting these requirements gives the owner tax benefits. Examples are individual savings accounts, more commonly known as ISAs in the UK, where investors are allowed to invest a certain amount of money each year (announced by the government at the beginning of each fiscal year) to trade or invest, for which they are not required to pay taxes. This bank provides a duty-free investment opportunity in addition to the usual duty-free threshold, which is calculated for investments outside this container. Therefore, investors are strongly advised to consult with a professional accountant to discuss their tax issues and explore the options available to them in their countries.
The only way to achieve your investment goals is to invest at a risk level that matches your assessment of risk tolerance. You can measure your risk tolerance, taking into account objective indicators such as your investment goals, the time horizon for each goal, the need for liquidity, etc. You can increase your risk tolerance by setting long-term goals, increasing your savings, using methods other than online investments, and reducing your need for current liquidity. These things, of course, are easier said than done, especially when you consider that you never know when your finances will hit you.
To analyze the price behavior of cryptocurrencies, you need a charting tool for proper analysis. But your work as an investor is not finished when you earn or lose money. As cryptocurrencies become a recognized asset, you need to make sure that you fulfill your liabilities for living by paying taxes. To do this, you need to track your trading activity. Most crypto exchanges and brokers provide trading tools, such as charts for technical analysis. However, their charting services may not allow you to use advanced technical analysis methods. In this case, it is better to use professional instruments.
By definition, liquidity risk is the risk of the inability to quickly sell the asset at a reasonable price. Liquidity is important to any traded asset. The Forex market is considered the most liquid market in the world. But even there you might discover a liquidity problem. If you trade currencies with a very low volume, you may not even be able to close your deal, because prices simply will not move! When liquidity is low, the risk of price manipulation also comes into play. One large player can easily move the market to his advantage by placing a large order.
The cryptocurrency market whales often move small altcoins using their huge capital. On the other hand, as investing in cryptocurrency becomes more accessible and acceptable, the market may become more liquid. Increasing the number of reliable cryptocurrency exchanges will enable more people to trade. Crypto ATMs and payment cards appear to help increase cryptocurrency awareness and recognition in day-to-day transactions.
ZenLedger will help you manage your crypto taxes with our crypto tax software. Our tool prepares profits and losses statements for you and your tax professional. Whether you are a miner, a day trader, or a Hodler, ZenLedger helps you find ways to minimize your tax bill.
Our team is available 24/7 and ready to help resolve any issues with your tax report. Feel free to contact us at any time! Don’t postpone your tax filing. Do it now!