Last Updated on December 16, 2022 by Ben
We will talk about how to avoid taxes on Bitcoin – the IRS classifies cryptocurrencies as property and not cash. This means that Bitcoin transactions are treated as the sale of stocks and other investments. If you buy cryptocurrency, it is not taxed. But if you sell it, trade it, or use it to buy things, then the IRS will charge taxes.
Table of Contents
- The Rules on Bitcoin Tax
- Tax Rules for Buying and Selling Bitcoin
- Trading of Crypto and Long-term vs. Short-term Gains
- Exchanging One Crypto for Another
- Using Cryptocurrency for Goods or Services
- Crypto Losses
- Crypto Forks and Airdrops
- Crypto Mining and Staking is Ordinary Income Taxed at Regular Rates
- Record Keeping and Reporting are Required
- Using an IRA to Defer and Obtain Tax-free Gains on Cryptocurrency Profits
- Tax Tips for Bitcoin
- How to Avoid Taxes on Bitcoin
The Rules on Bitcoin Tax
The IRS classifies cryptocurrencies as property, not cash or currency. That means it treats Bitcoin transactions like sales of stocks and other investments. Purchasing cryptocurrency with cash and holding on to a position isn’t a taxable transaction, but selling, exchanging, or using it to purchase goods or services is.
The Internal Revenue Service has yet to officially classify cryptocurrencies. However, in its notice 2014-21, the organization classified it as an asset similar to property. Taxpayers filing with the IRS are now subject to a question about whether they had any cryptocurrency transactions on their federal taxes during the given tax year.
Different kinds of taxes apply to different purchases. But because Bitcoin is different, there are many exceptions.
Tax Rules for Buying and Selling Bitcoin
If you buy Bitcoin and sell it for a profit, you must pay capital-gains taxes. This is the case whether you sell Bitcoin for dollars or if you trade it for another cryptocurrency. Or, if the price of Bitcoin goes up, you give it to someone else as part of a sale. You must pay capital-gain taxes on the difference between what you paid for it and what it was worth when you sold it.
Trading of Crypto and Long-term vs. Short-term Gains
When you buy crypto, you’ll need to track its value. You also need to follow the value when it is sold or exchanged.
For example, if you bought Bitcoin for $40,000 and then sold it in exchange for $50,000. This is a gain of $10,000. The rate that you will be taxed depends on how long you owned Bitcoin.
If you held Bitcoin for more than one year, your tax rate is around the range of 0-20%. Basically, there are three types of tax rates for capital gains. The first one is 0%, and it applies to people who make less than $40,000 if they are single or under $80,000 if they are married (or under $80,000 for the person making money). The second rate is 15%, and it applies to people who make $40,000-$200,000 if they are single or under 80-300k if married. The third rate is 20%, and it applies to all other taxpayers.
If you have held onto your Bitcoin or other cryptocurrencies for less than a year, then a higher rate will be applied as your tax. This percentage varies depending on how much money you make.
If you keep the Bitcoin or other cryptocurrency for a year or less, you are subject to short-term capital gains rates. The rates vary depending on your modified, adjusted gross income.
Exchanging One Crypto for Another
If you have one kind of cryptocurrency and then trade it for another, you will have to pay taxes. For example, if you bought $40,000 worth of Bitcoin one month and then changed it for Ethereum, later worth $60,000, you have a taxable gain of $20,000.This is correct for any length of time that you held the Bitcoin. It does not matter if it was a short time or if you had it for years.
Using Cryptocurrency for Goods or Services
Once you exchange cryptocurrency for goods or services, you will be taxed on the increase in the value of that cryptocurrency.
Suppose you bought a Tesla with a $100,000 value of Bitcoin. You would need to keep track of when the Bitcoin was purchased and pay tax on the gain. If the Bitcoin were bought for $60,000, there would be $40,000 when it is exchanged for the Tesla.
If you sell Bitcoin for over a year, it will be a long-term capital gain. Selling Bitcoin if you held it for less than a year will be taxed at short-term capital gains rates.
If you buy and sell bitcoin for a loss, you are entitled to a tax loss. It is possible to lose money when you sell or exchange crypto. If you sell at a loss, it can offset other gains from trading.
You can use your short-term crypto losses to offset your short-term gains, and you can use your long-term crypto losses to offset your long-term profits. Crypto losses can also offset gains from other investments like stocks or funds. If you have more losses than crypto gains and stock, fund gains, or ETF, then up to $3,000 of the loss can be used to offset your other income like wages and self-employment income.
Some losses cannot be used to reduce your taxes in a year. If this happens, then you can use the loss to reduce any future income in the years that come.
Crypto Forks and Airdrops
In 2019, the IRS clarified two items that can occur on a crypto blockchain.
The first is a fork. There are various kinds of forks that can happen, but what you need to know about taxes if a new coin comes from this fork is that if you got the new coins, they are considered taxable as ordinary income to the recipient.
In 2019, the IRS decided that if you get new coins in an airdrop, they are taxed as ordinary income. This means they will be at regular income tax rates. Airdrops are a way to show people your new coins or tokens. They can be free, but they are usually just for promotions.
Crypto Mining and Staking is Ordinary Income Taxed at Regular Rates
Cryptocurrency mining and staking are when you use a computer to make new digital currency for the network.
If you are mining, that means your computer solves math problems in exchange for the coins. When you’re staking, your computer helps to confirm transactions on the network. This type of income is ordinary income for tax purposes.
The owners of these computers typically receive cryptocurrency from the network in exchange for what they do.
If you have a computer that you use for cryptocurrency mining or staking, then you will get cryptocurrency in exchange. You must pay tax on the cryptocurrency you received to IRS. The payment in crypto is taxable income, just like if you are paid in dollars.
The value of the cryptocurrency you have when it is received is called the “basis.” If the value of your cryptocurrency goes up after you get it, then you will pay taxes on the increase in value later when you sell or exchange it.
So, let’s say you earned $1,000 from crypto-mining, and then you sold it three months later for $1,500. The first $1,000 will be taxed as regular income. The $500 that the bitcoin is worth after you earned it will be treated as a capital gain.
Record Keeping and Reporting are Required
When you buy, sell, or exchange cryptocurrency, it is complicated. You have to keep track of your records when you do it. The responsibility for doing this falls on the person who owns the cryptocurrency.
There are a lot of apps to help you track cryptocurrency. You can use them to make sure that you pay your taxes.
There are two apps called CryptoTrader.tax and Cointracker.io that help you find how much money you have made or lost with your crypto for tax purposes. The apps also show you the value of your coins at different points in time since they may change in value over time. There are around ten companies with an app that helps you take care of your cryptocurrency taxes.
Using an IRA to Defer and Obtain Tax-free Gains on Cryptocurrency Profits
Roth IRA is a good way to start investing. You can put money in it and then take it out when you retire. When you trade crypto with your Roth IRA, you won’t have to pay taxes on your profits because they are not subject to tax and do not show up on your 1040 personal tax return.
Some people who bought cryptocurrency early found it hard to pay taxes. They enjoyed significant increases in value, and then they had to spend a lot of money in taxes when they sold or exchanged the cryptocurrency.
People like the Roth IRA because it doesn’t charge them any tax when they invest and earn money. They can also save their money until retirement age, which is 59 ½ years old.
Tax Tips for Bitcoin
Virtual currency like Bitcoin has become more popular in recent years. Bitcoin can be used to pay employees and to buy things at some stores. The IRS recently said that if you buy or sell virtual currency, you should be taxed.
Convertible Virtual Currency is Subject to Tax
Bitcoin is a type of currency that you can use to buy things. It is called a convertible virtual currency because it has an equivalent value in real money.
The sale of a convertible virtual currency, like Bitcoin, has tax implications. It is not the same as buying anything else. The IRS has answered some common questions about the tax treatment of transactions with Bitcoin in its recent Revenue Ruling 2019-24 and Frequently Asked Questions article. But how you hold and use your Bitcoin could affect your taxes.
Bitcoin Used as Payment for Goods and Services Taxed as Income
For employers using Bitcoin to pay employees, the IRS uses W-2 forms to report earnings.
In this business, you need to convert the Bitcoin value to US dollars as of the date that you make each payment. Keep records and be careful.
Salary paid in virtual currency is subject to withholding, similar to dollar salary.
People who work for a company must report their total wages in dollars, even if they are paid with Bitcoin. Self-employed people also need to convert the Bitcoin they receive into dollars as soon as they get it and then send in their taxes.
Bitcoins Held as a Capital Asset is Taxed as Property
If it is used as a capital asset, you should treat it as property. Like stocks or bonds, any gains from selling or exchanging Bitcoin are taxed depending on whether they used it as a capital asset.
Bitcoin miners must report if they received virtual currency as income.
Some people use software to mine Bitcoin by validating the validity of transactions, maintaining a ledger for all recent transactions, and processing them.
The IRS said that when a person is successful at “mining” Bitcoin and makes money from it, they have to put the earnings on their taxes. They have to know what the fair market value of the virtual currency was on the day they received it. If a person who mines Bitcoin is self-employed, their gross earnings minus allowable tax.
Ways to Transfer Bitcoin Tax-Free
Crypto is a type of money that can be exchanged for other types of money. Recently, there have been some corrections in the crypto markets. The IRS is worried about taxes, and they are looking for people who do not report their crypto to them. But, there are some ways you can transfer your crypto without triggering taxes.
These ways are: Giving Crypto As a Gift
If you want to give crypto as a present, then that is okay. You don’t have to pay any taxes. You don’t have to pay taxes for the person who gets it, and they don’t need to pay tax either. The recipient of the gift is subject to income taxes when they transfer or sell it.
You can avoid income taxes by making sure that gifts are really given as gifts. If you say you are giving something to someone, it’s important not to get stuck with the tax. Being on the receiving end of a gift can make people feel like they don’t owe any taxes. However, the IRS is very attentive to that claim and will investigate every time it hears ‘it was a gift.’
Giving Crypto to Charity
If you donate Bitcoin or other cryptocurrencies to a qualified nonprofit organization, you should typically get an income tax deduction for the whole value of the crypto.
If you buy something for $1,000 and then donate it when it is worth $10,000 to a charity, you will get a $10,000 charitable contribution deduction. It’s not just about the money – you won’t have to pay the capital gain or income tax on the $9,000 difference.
How to Avoid Taxes on Bitcoin
If you want to avoid paying tax on your cryptocurrency profits, you need to plan ahead. There are some ways for you to stop paying taxes on your cryptocurrency gains and your capital gains.
Avoid Bitcoin Tax with an IRA
You can make your investments tax-free if you buy them inside of a 401-k, traditional IRA, or other retirement plan. When you do this, the money will not be taxed until you start to take distributions from the account.
To buy cryptocurrency from a retirement account, you need to move the account outside of the US and then open an offshore IRA LLC. From there, this company can open an offshore bank account and wallet for your investment.
You will be the manager of the IRA. You will control what is invested in it, and you are the only one who can make decisions about it.
Renounce US Citizenship
Giving up your US citizenship is a way to stop paying the IRS for your cryptocurrency gains. The IRS will not have any right to take anything more from you because you don’t live in the US anymore.
US citizens pay US tax no matter where they live. If you move to Panama but keep your US passport, you still pay US tax on your trading profits. The only method to get free of the IRS forever is by giving up your American citizenship and obtaining a new blue passport that declares allegiance to another land.
If you want to give up your US citizenship, you will have to pay an exit tax and have a second passport in hand. Without a second passport, you cannot live in the US anymore.
Bitcoin was originally not classified as a currency, but it has since been categorized by the IRS as an asset. The penalties for not reporting bitcoin transactions can be very bad. If you buy something with your bitcoins, the government wants to know about it.
No matter what you choose to invest in, taxes are a crucial consideration. Otherwise, you might be paying a lot of money for taxes. If you hire someone to help with taxes, they will know the best way to do it. That is the secret to maximizing your investment rewards.