How to Avoid Taxes on Bitcoin Earnings?

• Blockchain Council
• October 08, 2024

When you deal with Bitcoin or any other cryptocurrency in countries like the U.S., the IRS treats it as property, not currency. This means that every time you sell, trade, or use Bitcoin, it’s considered a taxable event, similar to selling stocks.

So, how to avoid taxes on Bitcoin earnings?

Read ahead to find out the most effective legal ways to avoid taxes on Bitcoin earnings.

What Are Bitcoin Taxes?

First, it’s important to grasp the basics. When you sell Bitcoin, you must pay capital gains taxes. They change based on how long you’ve owned it. If you’ve held it for under a year, you will pay short-term capital gains taxes, which match your regular income tax rate (from 10% to 37%). If you hold Bitcoin over a year, you might qualify for long-term capital gains rates. These are more favorable and range from 0% to 20%.

How to Avoid Taxes on Bitcoin Earnings?

Reducing taxes on Bitcoin earnings in the United States can be tricky, but there are a few legal ways to lower what you owe.

Hold Bitcoin for the Long Term

One simple way to lower your taxes is to keep your Bitcoin for over a year before selling it. By doing so, you qualify for the lower long-term capital gains tax rates, which can save you a significant amount of money compared to short-term rates. This method, known as “HODLing,” fits with a long-term investment plan. The IRS taxes Bitcoin differently based on how long you’ve owned it. 

If you sell after holding it for over a year, your profits will be taxed as long-term capital gains. They usually have lower rates compared to short-term taxes. For instance, long-term capital gains taxes range from 0% to 20%, depending on your total income. On the other hand, short-term gains from assets held for less than a year are taxed at regular income rates, which can reach as high as 37%.

Utilize Tax-Loss Harvesting

Tax-loss harvesting means selling assets that are not performing well at a loss to reduce the gains you’ve earned from other investments. For instance, if you’ve made a $10,000 profit on Bitcoin but lost $8,000 on another cryptocurrency, you can reduce your taxable gain to $2,000. This strategy is commonly used towards the end of the tax year to minimize tax liabilities​. The IRS does not apply the “wash sale rule” to cryptocurrencies, so you can repurchase the same Bitcoin after selling at a loss without waiting for 30 days, a requirement that applies to stocks.

The IRS does not apply the “wash sale rule” to cryptocurrencies, so you can repurchase the same Bitcoin after selling at a loss without waiting for 30 days. This is a requirement that applies to stocks.

Utilizing Tax-Free Thresholds

Taking advantage of tax-free thresholds can also help. For example, if your annual income is below certain limits, you may not owe any capital gains tax on your Bitcoin earnings. In 2024, single taxpayers earning under $44,625 annually and married couples earning under $89,250 jointly won’t owe any long-term capital gains tax​.

Invest Through a Self-Directed IRA

Another effective way to avoid immediate taxes on Bitcoin is by investing through a self-directed IRA. These retirement accounts let you invest in cryptocurrencies and delay paying taxes on any profits until you take the money out during retirement. Roth IRAs are particularly advantageous because, although you contribute after-tax dollars, your withdrawals during retirement are tax-free.

Make Use of Gift and Donation Exemptions

Gifting Bitcoin is another legal way to reduce tax liabilities. The IRS allows you to gift up to $17,000 per year per recipient without triggering any gift taxes. Additionally, donating Bitcoin to a registered charity helps you get rid of capital gains taxes and gives you a charitable deduction, lowering your overall taxes.

Take Out a Crypto-Backed Loan

Rather than selling your Bitcoin, you might consider getting a loan with your cryptocurrency as collateral. This method allows you to access liquidity without triggering a taxable event. Since loans are not considered income, you can retain ownership of your Bitcoin while still meeting your financial needs.

Sell During a Low-Income Year

Timing your Bitcoin sales during a year when your income is low can also help reduce the taxes you owe. Lower income means you fall into a lower tax bracket, which could significantly decrease the capital gains tax rate you’ll pay on your Bitcoin earnings​. For instance, if your income is below $44,625, you may pay 0% in capital gains tax. Those earning between $44,626 and $492,300 could see a tax rate of 15%, and the highest earners might pay 20%.

Move to a Crypto-Friendly State or Territory

Some states in the U.S. have more favorable tax laws, including no state income tax. States like Florida, Texas, and Wyoming are popular choices. Additionally, Puerto Rico offers unique tax benefits, such as 0% capital gains tax for qualifying residents. However, relocating for tax reasons requires careful consideration of all the legal and lifestyle implications​.

Filing Your Taxes

When you file taxes, make sure to have precise records of all your transactions. This includes the dates, amounts, and the fair market value of Bitcoin when you bought and sold it.The IRS requires you to report these details on forms such as the 1040 and Schedule D. Misreporting or failing to report could lead to significant penalties​.

Importance of Record-Keeping and Professional Advice

Now, you know how to avoid taxes on Bitcoin earnings. No matter which strategies you use, it’s important to keep clear records of all your crypto transactions. This includes purchase and sale dates. Also, keep track of the cost basis for each transaction. Good records will simplify tax reporting and protect you during an IRS audit. Given the complexity of crypto taxes, talking to a tax expert who knows about cryptocurrency can be very useful. They can help you understand the tax rules and improve your strategy.

Conclusion

While you can’t completely avoid taxes on Bitcoin earnings in the U.S., several strategies can help you reduce your tax liability legally. To answer how to avoid taxes on Bitcoin earnings, we can say holding for the long term, utilizing tax-loss harvesting, or investing through a self-directed IRA, being informed and strategic about your Bitcoin transactions can make a significant difference. Always keep thorough records, and don’t hesitate to seek professional advice to ensure you’re making the most of these tax-saving strategies.

And if you want to learn the ins and outs of the crypto world, consider enrolling into the globally recognized cryptocurrency certifications like the Certified Bitcoin Expert™.