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The Secret to Lowering Your Taxes on Bitcoin

By Charlene Rhinehart, CPA - Mar 16, 2021 at 7:35AM

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Being aware of how taxes work can save you thousands of dollars.

As more investors flock to cryptocurrency, the price of Bitcoin (BTC -5.87%) continues to hit record highs. Many investors are waking up to triple-digit gains and are contemplating one of the toughest decisions they'll have to make on their investing journey: Should I hold, buy more, or sell? 

If you hold or buy more, you don't have to worry much about taxes. But once you press the sell button, you'll be on the IRS radar because you've triggered a taxable event. The good news is that you can lower your taxes by creating a strategy in advance. Here are some options to help you keep more of your Bitcoin profits in your pockets. 

Physical version of Bitcoin and dollar banknotes. Exchange bitcoin for a dollar symbol. Conceptual image for worldwide cryptocurrency and digital payment system.

Image source: Getty Images.

Hold your investments over a year 

Selling your investments before your one-year holding period can be costly during tax time. If you held your Bitcoin for a year or less, you will face short-term capital gains tax rates. Those rates are the same as ordinary income tax rates you pay on money earned from working a job, which are up to 37% for high earners.

If you have faith in the future of Bitcoin, holding your investment over a year will pay off during tax time. You'll face the 0%, 15%, and 20% tax rates -- the coveted long-term capital gains rates that are given as a reward to investors who are patient and loyal.

As you can see, your tax bill can potentially shrink when you hold your investment over a year. The difference in the short-term and long-term capital gains rates could lead to thousands of dollars in savings, depending on your income and filing status for the year.

Explore the benefits of tax loss harvesting 

If you earned mega gains on Bitcoin, you can reduce the tax impact of those profits through tax loss harvesting. It's a popular strategy that allows you to offset short- and long-term gains of the same type and then use the remainder to reduce other types of taxes. 

Let's say you bought Bitcoin at $13,000 and sold it three months later for $23,000. You would have a $10,000 short-term capital gain. If you have a $12,000 short-term capital loss from the stock market, this could reduce your Bitcoin profits and lead to a total capital loss of $2,000. Since your capital losses exceed your gains, you pay no taxes. 

The IRS allows you to deduct up to $3,000 of a net capital loss from your income every year. If your loss exceeds the limitation, you can carry forward the loss and apply it to future years until you've used up the entire amount of losses. 

Consider giving Bitcoin as a gift

Under the IRS gift tax rules, you can give Bitcoin or other cryptocurrencies valued at less than $15,000 without having to worry about taxes. This $15,000 tax exemption is per recipient and applies for 2020 and 2021. If the value of the Bitcoin gift exceeds $15,000, you as a donor would be required to complete IRS Form 709 when you file your annual tax return. Don't worry; completing Form 709 does not automatically mean you will have to pay taxes. As long as you haven't exceeded the lifetime gift tax exemption of $11.7 million in 2021, you don't have to pay taxes on the Bitcoin gift. 

In order for Bitcoin to qualify as a gift, it must be given to someone without receiving anything in return, or the value of what you received must be of a lesser value than the Bitcoin you gave. 

What's even better for the gift recipient is that receiving Bitcoin does not trigger a taxable event. Bitcoin gift recipients do not have to report it on their tax return until they decide to sell the Bitcoin. At the time of sale, the recipient will have to pay capital gains taxes. If you are giving Bitcoin as a gift, make sure the recipients know the cost basis of the Bitcoin you are giving so that they can properly calculate gains or losses. 

Choose the best tax strategy for you 

It's easy to dive into the world of Bitcoin, become mesmerized by quick gains, and turn a blind eye to taxes. But before you buy or sell, create a strategy to make your investing experience more rewarding. 

If you've been investing in Bitcoin over the last five years or even over the last year, you know that it's a volatile investment. The risks have been great, but the rewards over the past few months have been even greater. So make sure you enjoy more of your profits by identifying the best tax strategy. 

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