Tax season is right around the corner, and if you lost money in crypto last year, I have some good news for you!
The first thing we should discuss when it comes to crypto taxes is something called capital gains and capital losses. These are terms used to describe your trades, depending on if those trades made money or lost money.
This applies to anything you buy or sell, houses, cars, watches, stocks, and in our case… crypto. If you bought bitcoin for $20,000, and sold it for $30,000, you have a capital gain of $10,000. If you bought the same bitcoin for $20,000, and sold it for $15,000, then you have a capital loss of $5,000. This is important because if we make any gains at all, we’ll have to use them to calculate how much money we owe the government in taxes. Technically, we can use our losses as well, but we’ll get to that.
Another thing worth noting is that there are 2 types of gains and losses, long term and short term. To be simple, long term is for a gain or loss where the time difference between two trades is more than a year.
On the other hand, short term includes trades that are less than a year. As you can imagine, the US tax code favors long term holding, so you pay less taxes on your gains if you hold your coins or tokens for over a year. The max tax rate of long-term capital gains is 20%, while the max tax rate of short-term capital gains is 37%, so quite a big difference. Sometimes, holding your crypto for a few more months to save on capital gains taxes can make sense. You can learn more about filing your crypto taxes using this guide from CoinLedger.
For both capital gains, the money is taxed progressively. This means that each extra dollar you earn is subject to a different tax rate. The federal tax brackets are set up in buckets, with each bucket holding a larger amount of money, and each additional bucket being taxed at a higher rate. This means the more money you make, the more money you put into buckets with higher tax rates.
Due to this, if you have a high income one year, you are incentivized to lower your income through different legal methods to pay a lower tax bill at the end of the year. I’m gonna share with you some good ways to reduce your taxable income:
A traditional IRA is an individual retirement account that you can open for yourself and contribute up to $6500 per year, unless you’re over 50, then it’s more. Anyways, how this IRA works… is that you deposit $6500, then you can reduce your taxable income this year by $6500, lowering your overall tax bill.
This account is for retirement, so the money can be withdrawn before you’re 59.5, but you’ll pay a 10% penalty plus the $6500 or whatever you take out will be added to your income that year. So you’re effectively moving the tax bill you pay on $6500 from this year to a year when you’re in retirement… which hopefully will be a lower income year because you won’t be working.
Last year, my wife and I both contributed $6000 each, meaning a total reduction of $12,000.
Traditional 401k or Solo 401k
A traditional 401k is very similar to an IRA, except the limits are much higher than $6000 and sometimes your employer will even match what you contribute.
I do not have an employer, so I have a Solo 401k, and last year I contributed $60,000 to reduce my taxable income by $60,000… which saved me a ton in taxes and also gave me a nice retirement cushion (which comes in handy being in the volatile crypto space).
HSA (Health Savings Account)
An HSA works very similar to an IRA or a 401k, except the funds can only be used on qualified medical expenses. HSA stands for Health Savings Account, and it isn’t available to everyone, only those whose insurance offers it. Because of this, I didn’t contribute to an HSA.
Any money that you give to a charity, which can be proven with a receipt, can be used as a deduction to reduce your taxes as well!
There are charity DAOs out there which could be used to technically lower your tax bill while benefitting society.
Mining and Farming Deductions
Also, if you run your crypto income like a business, then technically you can write off any expenses related to making crypto money. Last year I mined ETH, and I wrote off the $4,000 mining equipment I bought, as well as the increase in my electricity bill.
This isn’t something you should take lightly though, as you should talk to a professional accountant about the correct way to deduct these.
Sell your crypto at a loss to offset capital gains
The past 5 methods have been ways to reduce your income specifically, but there’s a way you can reduce your capital gains as well. Let’s say you got lucky and earned $40,000 from a good mooncoin bet in early 2022. This means that you will have to pay taxes on that $40,000 if you sold… and since it’s short-term, you’ll be paying a decent chunk in taxes.
Well, let’s say you lost about $5,000 in a crypto scam, you lost another $10,000 in the FTX fiasco, and another $12,000 from trades that lost you money. This total $27,000 of losses. You can add these losses to your gain of $40,000, to reduce your real gain, or profit, to $13,000… which will lead to a much lower tax bill.
Carry over losses from last year
Let’s create another scenario where you still sold your $40,000 moonshot of profit, but you lost $100,000 in the FTX fiasco. Does this mean you can write off $60,000, meaning the government will owe you money? Well, not really.
You can only claim $3000 of losses in a single year. So if you really did earn 40k and lose 100k, then you could only claim 3k in losses this year. Next year though, let’s say you earn another 40k from another moonshot. Well, last year you had -60k losses, and you used 3k of that on your taxes last year. This means you still have 57k of losses from last year that you haven’t used yet… and you can carry those over to this year… meaning even 40k – 57k nets you -17k. Still, this is negative, so you can only claim a -3k loss… and you can carry over 14k of losses to next year.
Preparing Crypto Taxes
So now that we’ve gone over what capital gains are, the fact that you have to report your trades and income, and some ways we can lower our income… How do we actually do all that stuff? Isn’t it super complicated to go through and count the gains and losses of your trades one by one?
I’m glad you asked! This article is sponsored by CoinLedger, which is a tool that I’ve actually used for 2 years to prepare my tax paperwork when it comes to crypto. Literally I just input some numbers, import my exchange accounts, let them do the math, and then hand what they give me to download to my accountant, who thanks me for the simple papers that I just handed her. I want to show you actually what I do here, so let’s walk through it together!