How to Legally Avoid Capital Gains Tax on Cryptocurrency

As you know, capital gains tax (CGT) refers to the tax users pay on the profit (capital gain) they make when they sell, trade, or spend the virtual digital assets (VDAs). Note that the specific rules and rates depend heavily on the country’s tax laws. As for who must pay the capital gains tax, the seller of the capital asset is responsible for paying the tax on the profit they realize from the sale.

The tax is levied in the financial year in which the asset transfer takes place. While you cannot fully avoid the capital gains tax, you can legally reduce or defer it using certain strategies. This article will discuss some tips on how to do that, so keep reading to learn more. 

Strategies to Avoid Capital Gains Tax on Cryptocurrency

You can avoid or minimize capital gains tax using specific tax-advantaged strategies by simply not reporting transactions as illegal. Here are some of the legal methods to avoid the tax:

Rather than Selling the Crypto, Hold it

Understand that capital gains are only realized when you exchange, sell, or spend the crypto. So, holding on to your assets indefinitely can prevent a taxable event. In the case of death, the heirs will receive the asset with a stepped-up cost basis on the current market value. This allows the receivers to sell the crypto without paying capital gains tax on the appreciation throughout their lifetime. 

Gifting the Crypto to Another Person

There is an option to gift the crypto to another individual without triggering capital gains tax, up to the annual gift tax exclusion amount. Note that the recipients will take on the original cost basis, and they will be responsible for the tax if they sell it later at a gain. 

Making Investments through a Tax-Advantaged Retirement Account

Know that holding crypto in a self-directed Roth IRA (Individual Retirement Account) allows the gains to grow and be withdrawn completely tax-free in retirement. However, it is important to follow all IRS rules. 

Ensure to Qualify for 0% Long-term Capital Gains Rate

Note that your annual income, including the crypto gains, is below a certain threshold. This might make you qualify for a 0% federal long-term capital gains tax rate. 

Donating Appreciated Assets to Charity

There is an option to donate highly appreciated cryptocurrency directly to a qualified 501(c)(3) charity. This way, you can avoid paying capital gains tax on the appreciated amount and may be able to claim a charitable deduction for the full fair market value of the donation. 

Here are some strategies to minimize the tax liability: 

Try Tax-Loss Harvesting

Understand that you can strategically sell crypto assets that are not currently at a loss to offset your capital gains from other sales, including the gains from stocks, or up to the ordinary annual income. In case of the remaining losses, they can be carried forward to future taxes. 

Holding the Crypto for More than One year

Holding the cryptocurrency for more than one year before selling, the gains will be taxed at a lower, long-term capital gains rate. However, short-term gains will be taxed at a higher, ordinary income tax rate. 

Borrowing against the Holdings

Rather than selling the crypto, you can take out a loan using it as collateral. This is a smart move because loans are generally not considered income by tax authorities. Thus, it provides liquidity without triggering a taxable event. 

Optimizing the Cost Basis Method

Try using specific accounting methods such as ‘Highest In, First Out’ (HIFO) if you plan on exchanging or if the software allows it. This move will let you match the crypto you sell with the highest purchases you paid, thereby minimizing the calculated capital gain. 

Who Exactly must Pay this Capital Gains Tax?

Anyone who gains a profit or earns income from their cryptocurrencies is required to pay taxes. However, the specific rules and rate depend on the person’s country of residence and the nature of the transaction. Here are some of the general principles that make crypto a taxable event:

• Selling a cryptocurrency for traditional currency and realizing a gain. A profit from that is generally considered subject to capital gains tax.
• If you exchange crypto for crypto, that is, converting one type of cryptocurrency for another, you will be required to pay tax. Also, in case you made any gain on the disposed asset, it is considered a taxable event. 
• You will be triggering a taxable event when you use cryptocurrency to purchase goods or services.
• Earning crypto as income is also considered a taxable event. You will be taxed on ordinary income if you receive crypto as payment for services, staking rewards, rewards for mining, or for some airdrops based on their market value. 

Conclusion

While crypto was considered a tax-free domain in earlier times, the IRS and other regulatory authorities changed the game. They are catching up to the market trends, which means investors will now have to report their every transaction and use tax-efficient strategies to increase their total returns in the crypto market. There are strategies to avoid and legally minimize capital gains, but it is important to administer them correctly. Additionally, be aware that tax laws are subject to complex and keep changing. So, do thorough research before making any important decisions or consult a qualified and licensed tax professional.