Year-End Tax Tips And Strategies For Cryptocurrency Investors
With just six weeks left in the year, now is the time for cryptocurrency investors to take action on year end tax planning. Spending a little time now can result in big savings when filing your tax return in April.
First, Run The Numbers
Sitting down to add up your income and expenses for 2018 is nobody’s idea of a good time, especially during the holiday season. Unfortunately, it’s a mandatory exercise for serious cryptocurrency investors. Running the numbers now is the only way to figure out where you stand and what tactics you need to deploy before year end to minimize your potential tax liability.
The first step is to gather up information about your 2018 income and expenses. You’ll need to know your income year to date, as well as your anticipated income for the remainder of the year. This means you’ll need to calculate your crypto capital gains, as well as income from mining or staking. Software tools like bitcoin.tax can help with this step.
Next, identify the expenses you expect to deduct on your tax return. These would include mortgage interest, property taxes, and student loan interest. Remember, the Tax Cuts and Job Acts of 2017 took away the deduction for investment interest and other related investment expenses, so you won’t be able to include those this year (discussed below).
Once you have this information, your tax preparer should be able to use their tax software to calculate your estimated 2018 tax bill. Alternatively, H&R Block has a great free income tax calculator that you can use to run the numbers by yourself. If you’re married, don’t forget to test whether your taxes are lower as married filing separate. The TCJA fixed the tax rate difference between filing married filing jointly and married filing separately, which means that some taxpayers will actually benefit from switching methods.
Now that you know your estimated 2018 tax liability, it’s time to start looking at strategies for reducing the amount you’ll owe to Uncle Sam. We’ll cover some of the most common tactics in this article, but keep in mind that this is not an exhaustive list. It pays to do your homework and find as many tax-reducing strategies as possible for situation. A good tax advisor can help with this part, too.
Start By Minimizing Your Capital Gains
For cryptocurrency investors, the best tax planning strategy is to minimize capital gains. Unfortunately, this is usually easier said than done. Here are some ideas:
- Hodl: The simplest way to minimize you capital gains is to avoid triggering additional capital gains. This is tricky due to the current tax treatment given to cryptocurrency. Because the IRS classifies cryptocurrency as “property,” every exchange of cryptocurrency is a taxable event, even if it does not involve fiat. This means that moving your investment out of one cryptocurrency and into another will trigger capital gains. Make sure you’re deliberate about any crypto exchanges, and also keep in mind that using cryptocurrency to pay for goods and services will also be treated as a taxable transaction.
- Harvest Losses: The entire crypto market has lost more than 70% of its value since the beginning of the year, which means that many crypto investors are holding coins with significant unrealized losses. Selling these positions will trigger a capital loss, which can then be used to offset other capital gains and potentially up to $3,000 of ordinary income. Keep in mind that all capital gains are the same, so crypto losses can be used to offset capital gains from other sources as well, such as stocks and bonds.
- No Wash Sale Rule: One of the few positives that comes out of cryptocurrency’s classification as property is that crypto traders are not subject to the Wash Sale Rule. For stocks and other securities, the Wash Sale Rule prohibits traders from repurchasing an investment which was sold for a loss within the last 30 days. Fortunately, this rule does not apply to cryptocurrency and crypto traders are free to sell losing positions and then repurchase them. Just keep in mind that the IRS may claim such transactions lack “economic substance,” so it’s probably advisable to wait several days before repurchasing.
- Capital Loss Carryover: If you capital losses in 2018 exceed your capital gains, then you will have a carryover loss that can be used to offset gains in future years. Unfortunately, losses cannot be carried back to previous tax years.
Maximize Your Deductions
Maximizing deductible expenses used to be a cornerstone of year end tax planning. However, the Tax Cuts and Jobs Act of 2017 drastically changed the landscape for tax write-offs as described below. Although there are still plenty of planning opportunities for using deductible expenses to reduce your tax bill, they’re not as powerful as they used to be:
- Most Taxpayers Use the Standard Deduction: Each year, you have the choice to deduct your actual itemized deductions or take the standard deduction. Typically, the choice is determined by whichever amount is higher. Even before the TJCA, most taxpayers would take the standard deduction instead of itemizing. Starting in 2018, the standard deduction has doubled to $12,000 for single filers and $24,000 for married filing jointly, which means more taxpayers than ever will skip their itemized deductions and take the standard deduction instead.
- Tips for Itemized Deductions: You might decide that tracking itemized deductions is not worth the effort for 2018 considering how large the standard deduction has become. If not, then maximizing your itemized deductions is an easy way to reduce your 2018 tax liability, just make sure that your total itemized deductions will exceed the new standard deduction amount, otherwise such efforts are pointless. Here are some strategies to consider:
- Medical Expenses: Currently, the threshold for deducting medical expenses is 7.5% of your Adjusted Gross Income (AGI). However, that number is going up to 10% in 2019, which means that you’re better off paying medical bills in 2018 if possible while the threshold is still 7.5 percent. Consider paying medical debts or rescheduling procedures before the end of the year to get the most out of your medical expense deduction.
- State Income Taxes: If you live in a state with income taxes, make estimated payments towards your 2018 tax liability by the end of the year. These payments will be deductible on your 2018 federal income tax return as long as you itemize and are not subject to the alternative minimum tax. Just keep in mind that the TCJA put a $10,000 maximum on the deduction for state and local taxes.
- State Property Taxes: If you own real property, including your personal residence, make sure to pay your next property tax installment before the end of the year. Just remember that the IRS will not allow you to deduct any prepayment of property taxes that have not actually been assessed. Also, keep in mind that the $10,000 limitation mentioned above also applies to property taxes.
- Charitable Contributions: If you plan to donate to charity, consider making the donation with appreciated cryptocurrency or other assets instead of cash. You get to deduct the FMV of the cryptocurrency you donate (as long as it’s been held more than 1 year) and don’t have to pay capital gains tax.
- Miscellaneous Itemized Deductions are a Thing of the Past: Another knock to the itemized deduction under the TCJA is the loss of “miscellaneous itemized deductions.” Investors can no longer deduct expenses like investment newsletter subscriptions, safe deposit boxes, and fees for tax advice. However, the TJCA did not completely do away with investor deductions. You can still deduct margin interest and short-selling costs.
- Above-the-Line Deductions Are King: One set of deductions left relatively unscathed by the TCJA are “above-the-line deductions.” These deductions are subtracted from your income before calculating “Adjusted Gross Income.” Common above-the-line deductions include Health Savings Account contributions, moving expenses, and IRA contributions. Importantly, these deductions are available even if you don’t itemize. As a result, when it comes to reducing your taxes, maximizing above-the-line deductions will typically give you the most bang for your buck. Crypto investors should consider maxing out their 401(k), IRA contributions, and HSA contributions (if eligible).
- Business Expenses Are Still Deductible: Although itemized deductions took quite a hit under the TCJA, business expenses deducted on Schedule C are still enormously valuable. Although not all crypto investors have a Schedule C business, those who do will benefit from shift as many expenses as possible from the personal side of their return to the business side. For example, the home office deduction is no longer available as an itemized deduction, but is still allowable for Schedule C businesses.
Advanced Planning Techniques
For crypto investors with significant income in 2018, more advanced planning techniques might be required. These generally require the assistance of professional tax advisors, but can result in considerable tax savings:
- Charitable Remainder Trusts: Charitable remainder trusts (CRTs) are powerful tax planning vehicles and are especially effective for investors holding highly appreciated assets, such as Bitcoin. The exact details of the CRT are beyond the scope of this article, but the basic plan starts with transferring an appreciated asset into an irrevocable trust. The trustee then sells the asset at full market value and re-invests the proceeds into other income-producing assets. You pay no capital gains tax when the asset is sold, and you also receive an charitable deduction for the property transferred to the trust. The trust then pays you an annuity for the rest of your life, and when you die, the remaining trust assets go to charity. As a result, CRTs make it possible to reduce current year taxes while allowing you to convert highly appreciated assets into a lifetime income stream.
- Opportunity Zone Investments: The Tax Cuts and Jobs Act created a new investment vehicle called an Opportunity Fund. The new investment vehicle is designed to spur economic development by providing tax benefits to investors in low-income communities, known as Qualified Opportunity Zones. You get to defer tax on any capital gains that are reinvested within 180 days into an Opportunity Fund. After five years, the capital gains you rolled over get 10% reduction. Also, if you don’t sell the investment for 10 years, you do not have to pay capital gains taxes on any returns you received from the OpportunityFund. So, Opportunity Funds let you defer current year capital gains and also earn tax free returns going forward.
The Bottom Line
Cryptocurrency investors still have time to reduce their 2018 taxes and should review available strategies. Don’t wait until the last minute.
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