The price of Bitcoin (CRYPTO:BTC) has soared exponentially within the last year, allowing investors to quadruple their gains without lifting a finger. If you're thinking about selling a fraction or all of your Bitcoin investment, make sure you understand how taxes for Bitcoin work

Bitcoin is a decentralized digital currency that offers investors more autonomy than other investment options. But investing in it does not mean you are exempt from taxes. You may have to give the IRS a piece of the profits you earn. However, there's a way to lower your tax bill (or even legally pay no taxes on your earnings from cryptocurrency) if you meet the rules for long-term gains tax treatment. 

Here's a breakdown of what you need to know to reduce your tax bill on Bitcoin -- maybe even to zero --when you file your return.  

Excited man looking up as money is floating in the air.

Image source: Getty Images.

Time is on your side 

The IRS views Bitcoin as property instead of cash or currency. This means that selling your investment for a profit will trigger capital gains taxes just like the sale of stocks would. 

There are two types of capital gains taxes: short term and long term. If you hold your bitcoin investment for a year or less before selling it, you would have a short-term capital gain. Your earnings will be taxed at your ordinary income tax rates, which can be anywhere from 10% to 37%.

The best deal on your tax bill comes when you hold your Bitcoin investments for over a year, because the long-term capital gains tax rules are the key to unlocking the 0% tax bracket on your Bitcoin profits. 

Maximizing your gains 

The secret to make your way into the lower long-term capital gains tax bracket is to pay attention to your holding period and keep tabs on your taxable income. 

Long-term capital gains grant you access to the 0%, 15%, and 20% tax rates. To qualify for these favorable tax rates, you must hold your Bitcoin investments over a year before selling them. 

Then, pay attention to your income. A single filer can have taxable income up to $40,400 to claim the 0% tax bracket on long-term capital gains in 2021. Let's say you are single with a taxable income of $25,000 in wages and $15,000 in long-term capital gains from Bitcoin. You would be eligible to pay zero taxes on your Bitcoin profits because your total income of $40,000 is less than the threshold for single filers.

Once you cross that income threshold, you get bumped up into the 15% long-term capital gains tax bracket. So in the above example, if you had $20,000 in long-term gains from Bitcoin, the first $15,400 would get the 0% rate, but the remaining $4,600 would get taxed at 15%.

Obviously, you don't want to give up the chance to earn extra income just because some of it will get taxed. But if you have the option to choose when that income comes in, smart tax planning can save you some money.

Take a look at the 2021 long-term capital gains tax brackets below for your filing status and the income threshold that would qualify you for the 0% tax bracket. Married joint filers receive the largest income threshold -- up to $80,800 taxable income -- to pay zero taxes on capital gains. 

 Single Filers With Taxable Income of...

 Married Joint Filers With Taxable Income of...

Married Couples Filing Separately With Taxable Income of...

Heads of Households With Taxable Income of... 

...Pay This Long-Term Capital Gains Tax Rate

$0 to $40,400

$0 to $80,800

$0 to $40,400

$0 to $54,100

0%

$40,401 to $445,850

$80,801 to $501,600

$40,401 to $250,800

$54,101 to $473,750

15%

Over $445,850

Over $501,600

Over $250,800

Over $473,750

20%

Data source: IRS.

Don't forget deductions and other investments

Tax deductions make it a bit easier to land in the 0% long-term capital gains bucket. For example, the standard deduction lets you reduce your taxable income. In 2021, a single person can make up to $12,550 before having to share earnings with the IRS. A married couple can claim a standard deduction of $25,100. Also, contributing to a traditional IRA or 401(k) could help you reduce your taxable income so that more of your Bitcoin gains would qualify for lower rates. 

These deductions and long-term capital gain benefits also apply to profits earned in the stock market. Stocks tend to be less volatile than Bitcoin and have proved to be a great way to get started as an investor. Plus, the overall stock market has a track record that can help you better measure your chance for long-term success. 

No matter what you decide to invest in, make understanding taxes a priority, or hire a professional to help with the best strategies. That's the secret to maximizing the incredible rewards that come with being an investor. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.