What You Need to Know About Cryptocurrency Taxes Before the Hodldays
We know, taxes aren’t exactly the most exciting thing in the world.
But what we’re about to tell you is commonly misunderstood and could majorly work to your benefit. Majorly.
Don’t believe us yet?
Just keep listening….if you’re this far, all we’re asking is for you to consider the next 1,300 words or 5 minutes of time.
Consider this next statement: It seems like the U.S. tax code is geared against cryptocurrency traders, but if you do things right you could save yourself thousands of dollars in taxes.
You could save not just on those confusing ‘Bitcoin taxes’ you’re paying (should be paying), but thousands of tax dollars on all other forms of income. Indefinitely.
It works because the rules of this unexplored crypto-world open up tax advantages for traders.
You just have to know those rules.
The best part? We know those rules and we’re going to share with you.
Basically, it comes down to this: Despite IRC section 1091(d) and the Economic Substance Doctrine, the IRS classification of digital currencies as ‘property’ allows traders to create recordable ‘tax-realized’ losses that offset crypto gains and a predetermined amount of adjusted gross income, the remainder of which is carried over indefinitely through the entire amount of that recorded ‘capital loss.’
A little wordy? We know.
But if you stay with us we’ll figure this out together.
Let’s start real quick with a touch-up on the basics:
Crypto and Uncle Sam
As of March 25, 2014, the IRS classified Bitcoin and other digital currencies as “property” rather than “currency.”
Pretty controversial and raises several questions. Chief of which is:
— also —
“How can digital currencies even be property, when they exist solely in the shared electronic space?”
Well we don’t have all the answers on that.
Nonetheless, keep this equation in mind:
Bitcoin = Property
This leads us to our second idea:
A little about Capital Losses.
After offsetting Capital (or property) Gains, realized Capital (again, or property) Losses are capped at $3,000 per year.
This is for joint-married and single filers on personal tax returns. The cap is half that ($1,500) if you’re married but filing separately.
The important bit:
All losses exceeding that capped amount can be carried forward, indefinitely.
Put simply, if you lost money in the cryptocurrency market, you’re only one step away from paying less taxes.
You only have to ‘realize’ or ‘book your loss.’
If you’re anything like the rest of us in this current bear market, your crypto is worth a lot less than it was a year ago. Don’t worry, things will turn around. Until then the good news is this: You can use those losses to offset your taxable gains.
Even better: After offsetting capital gains, you can deduct your loss against ‘adjusted gross income.”
Let’s bring in Bitcoin Bartholomew.
So Big B. bought one (1) Bitcoin at $11,000.
It was January.
Now it’s December.
One (1) Bitcoin is worth $4,000
Smart trading? Not at face value…but don’t give up on ole’ Bart-boy just yet.
Bitcoin Barty knows that although technically he is down $7,000, the loss will never affect him if he doesn’t ‘realize’ it.
No, that’s not denial. It’s tax strategy.
In order to realize this loss, our tactical hero would need to know this:
Capital Losses are only realized when the cryptocurrency is sold. (Yes, this includes trading one digital currency for another. Even trading Bitcoin for whatever that fancy new breakout coin is. Unfortunately.)
Anyways, once Bartholomew sells his Bitcoin, he will no longer have just a technical loss. It will be considered a tax-realized loss.
Sounds bad, but that’s kind of the whole point — this is actually where the money saving comes into play.
How much could realizing a loss be worth?
It depends on how you do your trading but — potentially — a lot.
Remember, Bitcoin = Property.
Remember that after offsetting gains, Capital Losses are capped at $3,000 per year.
Let me show you how this plays out:
Let’s say that in 2018, B. Bart managed to make Capital Gains of $2,000
So he sells some of his Bitcoin, purposely incurring a Capital Loss of $7,000
(Remember that after offsetting gains, he is capped at a net of $3,000 in losses.)
So the result of his clever trading is this:
His 2018 Capital Gains of $2,000 is untaxed.
$3,000 of his other income (adjusted gross income) is also untaxed.
Plus, the exciting part.
In 2019, $2,000 of his other income will be untaxed!
So you could look at his Bitcoin outcome as a negative, or, you can see it as the two years of tax savings that it is!
And that’s with only $7,000 of ‘capital losses’….we should call him Smart Bart.
Moving on. Pay extra close attention to this next part.
IRC Section 1091(d) and why you should care.
Is all of this a new strategy? Not quite.
People have been trying to do this in stock-trading for decades.
The problem is the stock world is pretty volatile — not to say the crypto world isn’t — so all these traders decided they would ‘play it safe.’
They would sell their own stock to incur a loss, then quickly buy back the same stock. In doing this, they got their tax deduction and also were able to keep their stock until it rose back up.
Needless to say, the IRS caught on and decided this strategy was too good at saving money. They took action.
The IRS gave this clever strategy the name ‘wash sales’ and banned it under Section 1091 (d) of the tax code. So deductions made from a realized capital loss with a buyback within 30 days were now prohibited.
When it comes to stocks that is.
The fine print:
Section 1091’s prohibition of wash sales disallows a loss deduction of a sold ‘security’ (stock) if the same security is repurchased within 30 days of the sale.
However, if you remember: Bitcoin (and other virtual currencies) = property.
You read that right, that’s what we’re telling you.
Cryptocurrency is exempt from Section 1091(d).
Quick side note: the Economic Substance Doctrine
The Economic Substance Doctrine basically states that any transaction generated “without economic substance” for the sole purpose of creating a tax benefit is disallowed.
Seems like that could be a pretty hefty ‘gotcha.’
However ‘economic substance’ is considered met when you expose yourself to ‘market risk.’
…With the volatility and controversy of Bitcoin, it seems like even discussing cryptocurrency exposes you to a risk…
When trading crypto, most sources agree that if you’re going to incur a loss — one that also happens to be tax-advantageous — only a slight wait is necessary.
Because of the crypto-market’s tremendous price fluctuations, one to three days is likely sufficient exposure to market risk.
That’s a great deal shorter than 30 days.
Who knows what could happen in that amount of time.
Putting it all together
1) Because the IRS decided to treat digital currencies as property, your losses could mean a $3,000 deduction on your adjusted gross income plus your remaining loss is carried forward indefinitely.
2) In order to book a loss, you have to ‘realize it.’ This is done by selling your crypto (including exchanging your current crypto for another).
3) Thanks to the ‘new frontier’ of cryptocurrency, you can sell to incur a tax-realized loss, then repurchase it after waiting just a few days. You receive a deduction and still retain your crypto assets.
Have your cake and deduct it too: a slight consideration.
There are a few consequences to this strategy.
The effect depends on how you are recording your trading, and how you play the game. Repurchasing your sold crypto will reset its long-term capital gains position. Basically, when you decide to sell it again, your taxes will be guided by the new amount you purchased it at and the date purchased.
Again not necessarily a bad thing, but definitely important to keep in mind.
What should you do with all this information?
Go all in.
Sell your house and go full-time crypto trader.
This guy tried it.
If you find yourself taking major losses, at least you know they are deductible up to $3,000 and carried forward indefinitely.
For however many years that may take.