As the world of cryptocurrency continues to evolve, so does its relationship with taxation. Crypto investors, whether seasoned or new, need to understand the tax implications of their investments.
A new U.S. Treasury Department rule aims to require cryptocurrency brokers, such as exchanges and payment processors, to report user transaction information to the IRS. This would be facilitated through a new tax reporting form called Form 1099-DA. The form has been designed to make it easier for taxpayers to determine their tax liabilities, reducing the risk of unintentional non-compliance.
Furthermore, the proposal expands information reporting rules to include digital asset brokers — covering centralized and decentralized trading platforms — crypto payment processors, and certain online wallets. The rule is set to apply to cryptocurrencies like Bitcoin and Ethereum, as well as non-fungible tokens. Brokers would need to send these new forms to both the IRS and digital asset holders to aid in tax preparation.
The proposed tax change stems from the 2021 Infrastructure Investment and Jobs Act, which aimed to enhance tax reporting requirements for crypto brokers, extending reporting requirements for large cash transactions to digital assets. The Treasury Department estimates these rules could generate approximately $28 billion in revenue over a decade. The rules are expected to apply to brokers in 2025 for the 2026 tax season, aligning with broader efforts to address tax evasion risks associated with digital assets and ensure compliance with tax laws.
The crypto industry’s response to the proposal has been mixed. Some believe it could provide valuable information for everyday crypto users to comply with tax laws, while others argue it won’t simplify tax filing or improve compliance. Currently, crypto users are required to report digital asset activities on their tax returns, including trades, even if they resulted in no gains. Feedback on the proposal is being accepted until Oct. 30, and public hearings are scheduled for Nov. 7-8. Democratic senators, including Elizabeth Warren of Massachusetts, have urged swift implementation, citing concerns about tax evasion and abuse of the system by crypto intermediaries.
Until the new rules take effect, here are five tax strategies that can help current crypto investors save on taxes:
1. Long-term capital gains. The IRS treats cryptocurrencies as property, not currency. This means capital gains tax rules apply. If an investor holds their cryptocurrency for more than a year before selling or trading it, they’ll be taxed at the long-term capital gains rate, which is typically lower than the short-term rate. This strategy encourages investors to hold onto their crypto investments for longer periods, potentially reaping more significant benefits.
2. Tax loss harvesting. This tax strategy involves selling cryptocurrencies that have experienced a loss to offset the capital gains from profitable sales. By doing this, investors can reduce their overall taxable income. It’s essential to be aware of the “wash sale'” rule, which prohibits them from claiming a loss if they repurchase the same or a substantially identical asset within 30 days before or after the sale. However, the IRS has not clarified whether this rule applies to cryptocurrencies, providing a potential loophole for investors at this time.
3. Gifting and inheritance. Gifting cryptocurrency can be a tax-efficient strategy. In 2023, a taxpayer can gift up to $17,000 per person without incurring any gift tax. If they inherit cryptocurrency, the cost basis is stepped up to the fair market value at the time of the donor’s death, potentially reducing the amount of taxable gain when the heir sells the crypto.
4. Charitable donations. Donating cryptocurrency to a registered nonprofit organization can provide a double benefit. The taxpayer can deduct the fair market value of the crypto on the date of the donation from their taxable income, and they also avoid paying capital gains tax on the appreciated value of the donated crypto.
5. Utilize tax-advantaged retirement accounts. Some self-directed IRAs allow for cryptocurrency investments. Any gains from these investments grow tax-free until retirement when distributions are taxed as income. This strategy can defer the tax liability and allow for compounded growth of the investment.
Navigating the tax landscape of cryptocurrency can be complex, and the tax rules surrounding this financial product are changing fast. It’s crucial to keep detailed records of all transactions, including the date, value, and nature of each one. Engaging a tax professional familiar with cryptocurrency can also be beneficial. As the IRS continues to refine its stance on cryptocurrency, staying informed and proactive in their tax planning strategy is key.
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