The Key Legal Techniques of Avoiding Crypto Taxes
In this section, I will tell you how you can avoid paying cryptocurrency taxes, legally!
Taxes aren’t a fun topic, for anyone. It’s often complicated and convoluted - however, they are also mandatory to be paid, for everyone. That being said, there are a few different ways of how you could avoid paying cryptocurrency taxes, or at least lower the amount that you would need to pay, in the first place.
Now, I do have to point this out - when I say “avoid paying taxes”, I’m only talking about the 100% legal methods of doing so. Furthermore, none of the information in this section should be taken as tax advice - it’s simply me sharing some interesting insights into the tax system, and the loopholes found within.
In this section, I will tell you what are the crypto tax laws in the United States, and how you can avoid cryptocurrency taxes, legally.
Let’s get to it!
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How to Avoid Crypto Taxes? (Legal Ways Explained)
What are Crypto Taxes?
In the US, the institution responsible for collecting taxes is called the IRS, or the Internal Revenue Service. Every year, residents of the country need to pay their taxes to the IRS - cryptocurrency taxes included.
In order to continue, you need to understand one fundamental term - capital gains.
So, imagine that you’ve bought a car, in January. Throughout the year, the value of that car increased, due to the manufacturer putting out a statement that this specific model would be discontinued. Now, if you choose to keep the car, you’re all good - no need to pay anything to the IRS.
However, if you do end up SELLING the car, for more money than you’ve bought it for, the profit will be considered as capital gains. These gains are then taxed by the IRS.
Cryptocurrency taxes work the exact same way. If you bought Bitcoin for, say, $1000, and by the end of the year your BTC is now worth $1500, selling it will impose a capital gains tax for that $500 - simple maths!
This is actually where the very first loophole of avoiding crypto taxes comes in - HODLing. Don’t want to pay taxes? Just don’t sell your Bitcoin!
If you choose to hold your cryptocurrencies, no matter how much the value would increase throughout the year, you won’t need to pay any taxes on them. The capital gains tax is only imposed when you choose to make a sale.
In addition to capital gains taxes, you should also be aware of the fact that trading crypto is considered a taxable event in the eyes of the IRS, as well. So, if you take your Bitcoin, and trade it for Ethereum, this transaction will be taxed, at the end of the year.
The taxes for this type of a transaction will be calculated at the moment the trade is made. So, let’s say, you trade $100 worth of BTC for $100 worth of ETH in April. Now, the cryptocurrency market experiences a price crash towards the end of the year, and the same amount of ETH is now worth $20. Well, you will still need to pay taxes as if it would be worth $100, since the tax was calculated when you made the trade!
How will the IRS know that you’ve made this trade? Well, if you trade on centralized exchanges, such as Binance or Coinbase, your activity will be automatically reported to the IRS. If you perform the trade on a decentralized exchange, such as Uniswap, it’s up to you to report your trades to the financial institution, instead.
What happens if you choose NOT to report these trades? Well, for starters, that’s illegal, and you might get in a lot of trouble for doing so. With crypto tracking becoming increasingly more advanced, the risk for avoiding taxes this way is getting much higher, as well!
Going back to the capital gains tax, that’s actually a way of how you can lower your taxes, as you sell your crypto - it’s called a long-term capital gains tax. You see, this is a benefit of HODLing, for some time - if you hold and don’t sell your cryptocurrencies for at least a year after you acquire them, your capital gains taxes will be much smaller!
In order to understand this better, you need to first understand the difference between short and long-term capital gains taxes.
The short-term capital gains tax is imposed if you hold your asset - say, your Bitcoin - for a short period of time, and then sell it. If this is done in the same tax year, then it’s considered to be a short-term capital gain. Naturally, though, there are various details surrounding the process, and you should always do in-depth research of your own, before making any decisions - this isn’t tax advice, mind you!
Long-term capital gains taxes apply to people who choose to hold their assets, well… Long-term! In many cases, the “long-term” constitutes a time period of over a year. So, if you do end up holding your Bitcoin for over a year, your capital gains tax would become much lower.
The actual tax rate will depend on your yearly income. However, in many cases, the long-term capital gains tax can be up to half the size of the short-term tax. So, while you will still need to pay taxes, it’ll be much less than what you’d pay the first year around!
Moving on, another way of how you could avoid cryptocurrency taxes legally is actually one that’s unfortunately familiar to a lot of crypto investors. In order to not have to pay taxes for the year, your losses need to be higher than your profits.
So, let’s say, you’ve bought Dogecoin for $100, in the middle of the year. The prices were very volatile, and at some point, you just decided to bite the bullet, and sell off your Doge for $70, with a $30 loss. This loss would then be deductible from your taxes, at the end of the year.
Naturally, this isn’t an ideal scenario. However, if you do find yourself in a situation like this, there’s at least the condolence of potential taxes being lowered, or negated, in general.
Next up, one of the more-radical ways of how you can avoid paying crypto taxes legally within the US is by leaving the country. Many people who have made a lot of crypto gains choose to travel and live offshore, in countries that have more-favorable tax laws. When it comes to the US, one of the most-popular travel destinations of this kind is Puerto Rico.
As you can probably agree, this is actually a really extreme measure to take, in order to avoid paying taxes in the States. Do keep in mind, however, that there are additional details surrounding this loophole, too! For starters, in most countries, you will need to spend some time there and register yourself within the country in order for the tax cuts to apply to you.
Furthermore, if you’ve already been trading cryptocurrencies for some time now, and have managed to accumulate fairly large amounts of wealth thanks to that, you will still need to pay taxes in the United States, even if you do choose to leave the country.
Moving on, another method of avoiding crypto taxes legally that has been becoming increasingly more popular is starting a crypto Roth IRA of your own. Now, this is where I’ll need to get a bit more technical, so do bear with me. And remember - none of this is tax advice, and the material should only be viewed as educational!
So, a traditional IRA is an “Individual Retirement Account”. The concept is surrounded by a lot of rules and technicalities, but to keep it simple, you should know that an IRA is an investment account that allows you to invest towards your retirement. The major point here is that, until you retire and decide to take the money out, anything that you put in is tax-deductible.
Now, let’s say that you’ve decided to put $1000 into your IRA. When the time to pay taxes comes around the corner, you will be able to deduct that $1000 from your taxes, in the form of a “loss”. The IRA kind of tells you “hey, don’t pay taxes on that money just yet - you’ll pay us when you take the money out, in the future”.
With a Roth IRA, everything’s the same, except for one, single detail - you pay taxes NOW, and get to take out the money later without paying any taxes on it. So, that $1000 that you invest? Well, it won’t be deducted from your taxes this year, but when that investment grows, and you reach your retirement age and want to take the money out, you won't be required to pay any taxes.
So basically, the main difference between the two is that with an IRA, you pay taxes LATER, and with a Roth IRA - you pay them NOW.
Another point that’s worth mentioning here is that your IRA account can also be treated as a savings account. So, you place in money, pay taxes on it that year, and are then able to withdraw that money at any point in time, without paying any more taxes for withdrawals up to the sum that you’ve placed in there, in the first place!
Wow, I admit - IRAs are among the more-complicated aspects of the tax world. To tell you the truth, I’m actually skipping a lot of the details, and only giving you the general picture, so that you could at least understand the fundamentals of the concept.
All of that leads us to the crypto Roth IRA part. It is possible to set up a cryptocurrency Roth IRA account so that you’d be putting your cryptos towards your retirement fund.
Obviously, there are things to keep in mind here, before doing this. First of all, a crypto Roth IRA would only make sense if you believe that the value of cryptocurrencies is going to be higher in the future than it is now, as well as that you’ll be in a higher tax bracket when you retire, as opposed to where you are now.
However, with a bit of luck and strategic planning, you could actually avoid a lot of potential crypto taxes, by opening up a crypto IRA account!
One more big method of how you can avoid crypto taxes in a legal manner is loans. Specifically, I’m talking about taking out a loan in order to buy cryptocurrencies.
When you take out a loan for, say, a car, that car then acts as a backing for your loan. The same is true with crypto - if you take out a loan to buy Bitcoin, that BTC will act as backing for your loan.
Now, the thing that you buy with your loan money isn’t taxed. So, that BTC that you’ve bought - it’s not subject to being taxed! You can use it (trade it, invest it, and so on), and reap the benefits, without paying any taxes.
Obviously, this comes with certain risks, and proper research needs to be done in order to not get into financial trouble. Taking out a loan for crypto is actually much simpler than you’d think, but you should only do so for cryptocurrencies that you truly believe in, and that are long-term projects!
Up to this point, we’ve covered a few of the most popular methods of how you could avoid cryptocurrency taxes, completely legally. So, which of these methods seems the most logical one?
Personally, I believe that the best way to avoid cryptocurrency taxes in a legal manner is to hold your crypto, for a long time to come. If you’ve bought coins and tokens that represent projects that you truly believe in, then you will also believe that those assets will rise in price, with time.
And, with cryptocurrency mass adoption being a hot topic, who knows - maybe crypto taxes will be abolished, altogether, at some point in the future? Or, at the very least, if you hold crypto for a long time, maybe the taxes will get significantly lower than they are now - that’s something to look forward to!