This material has been prepared for informational purposes only and is not intended to provide and should not be relied on for tax, legal, or accounting advice. You should consult a tax, legal, and/or CPA before engaging in any transaction.
Are you aware of blockchain explorers such as EtherScan or SolScan? To put it simply, blockchain explorers are the Google of the crypto world. These types of new-world tools you need to become familiar with as you venture into the alternative asset world of cryptocurrencies. To get started, you should know that you need to use a blockchain explorer that supports the blockchain you wish to track. If you try using a Bitcoin block explorer to track Ethereum transactions, you will not get very far.
And there is much more to learn about maximizing profits in the cryptocurrency world…
Keep a Clean Wallet
For your peace of mind and to allow your accountant to help minimize taxes while maximizing profits, you want to maintain good wallet hygiene. Depending on your activity level, you probably need multiple crypto wallets. Every activity, including staking, mining, and NFT purchases, should be in its own wallet to make different transactions easier to reconcile. At a minimum, you need different wallets that keep your personal transactions separate from your Solo 401k retirement account transactions.
As you set up your cryptocurrency management system, consider your wallet and filing naming structure. Spreadsheet files related to a specific wallet should be easy to identify as relating to the specific wallet. Although your different wallets will span many years, spreadsheets should generally track your activities for individual years. If your activity level is high, you may even have separate files (or tabs) for individual months. The more organized you are with your crypto transactions, the easier it will be for your crypto tax accountant at the end of the year.
The naming system that you use is also key to your overall success.
Blockchain is about full automation. As a cryptocurrency investor, you want your processes automated as much as possible. Cryptocurrency is still a relatively new asset class, and change is inevitable over time. Automated data and processes are searchable and linkable. As this asset class matures, automation will enable you to backtrack through current and previous years of transactions and data.
Astute investors understand that the IRS will look closely at how cryptocurrency is reported on your taxes for the next several years. Although you don’t need to report transactions to the IRS inside your Solo 401k, you will eventually make withdrawals during retirement. During retirement, cryptocurrency transactions and profits inside your Solo 401k should be treated the same as any other profits and withdrawals from other asset classes. Currently, the IRS treats cryptocurrency transactions as either long or short-term capital gains or losses. Maintaining automated records of your trades makes it easy to track long or short-term capital gains or losses.
The more automated your processes are, the better. One way to achieve this is by selecting the right crypto tax software that automatically calculates your profits and losses while simultaneously keeping a record of your transactions. Many of these also provide qualifying tax deductions and tax credit suggestions based on your specific information. Of course, engaging with an experienced crypto CPA before year-end is essential.
The sooner you establish a relationship with a crypto specialized accountant, the better your portfolio will be managed and tracked.
How Cryptocurrencies Can Impact Your Taxes
If your cryptocurrency transactions take place inside your Solo 401k or Roth Solo 401k, you should NOT owe any taxes on those transactions. This would be a situation when you want these assets in a wallet separate from other cryptocurrencies that are not in a tax-advantaged retirement account.
Something you don’t want to do is assume the IRS hasn’t caught up with cryptocurrency technology. The IRS is well aware that cryptocurrencies are being traded to make an investment profit. Depending on the transaction type, cryptocurrencies are indeed taxable. Taxpayers who use a regulated, centralized exchange, such as Coinbase, are under the watch of the IRS to ensure that the taxpayer is complying with all tax rules.
The IRS classifies crypto as “property” for tax purposes. This means virtual currency held outside of a tax-advantaged account is taxed similarly to any other assets you own. A common way of thinking of crypto is the same as you may think of gold. For IRS purposes, gold, securities, and crypto all fall into the same category as an investment property that owes taxes when sold or traded for capital gain. Because of this, certain cryptocurrency transactions are considered to be taxable assets, which trigger either a short or long-term capital gain or loss when disposed of.
However, cryptocurrency’s tax implications depend on how the cryptocurrency was acquired. An example of a non-taxable acquisition will be if you receive it as a credit card reward. This type of reward is not considered taxable income but rather a rebate. On the other hand, if the cryptocurrency you hold outside of your Solo 401k is loaned to a person or business in exchange for earning interest, that interest in the form of cryptocurrencies is a taxable acquisition.
Still, there are differences between how security trades are taxed and how crypto transactions are taxed. One of these differences involves what is known as “wash sale rules.” The wash sale rule doesn’t apply to cryptocurrency. The wash sale rule means investors cannot claim losses on “securities” that are sold at a loss and reacquired within 30 days. But the IRS has classified cryptocurrencies as “property” rather than “securities.”
If you are trading crypto outside of your Solo 401k, these tips can be used to lower the year’s capital gains tax.
More Strategies to Lower Cryptocurrency Taxes
Another method to keep your cryptocurrency taxes to a minimum is using tax loss harvesting. Keep in mind that we are discussing cryptocurrency transactions that happen outside of your Solo 401k. Tax loss harvesting works by offsetting your capital gains with capital losses incurred during the tax year. It’s also possible that the losses are carried over from a previous tax return. As U.S. investors are taxed on net capital gains, by offsetting capital gains with capital losses, you help lower your taxable income.
Gifting it can be a tax strategy if you are in a position to share your cryptocurrency wealth with others. Any cryptocurrency given as a gift has no income tax obligation, and receiving crypto as a gift isn’t a taxable event either. If you receive a gift with a fair market value over $15,000, you’ll be required to submit a gift tax return primarily for informational purposes.
Getting back to keeping automated and detailed transaction records, finding the optimal cost basis can be a way of reducing and minimizing taxes owed on crypto trades. When you set up your files, you’ll want to include this information:
- The market value of the cryptocurrency at the time of the transaction (proceeds).
- How much you paid for the coin (cost basis)?
- The difference between the two above prices and whether it’s a gain or a loss.
The basis is something you know before you complete a transaction, such as selling a crypto coin for U.S. dollars. It may not be intuitive to you, but to lower your tax obligation, you want to sell the crypto coin you paid for most. The basis amount significantly impacts the taxes you pay when you eventually sell your cryptocurrency. The higher your cost basis, the lower your tax bill. By talking with your crypto tax accountant, it’s possible to optimize your cost basis via tax lot ID methods such as:
- First in, first out (FIFO): Assets acquired first are sold first.
- Last in, first out (LIFO): Assets acquired last are sold first.
- Highest in, first out (HIFO): Highest-price assets are sold first.
The IRS allows specific identification accounting for cryptocurrency transactions. In this method, you keep track of every item of inventory — every tax lot. Although Specific ID requires more documentation than other methods, blockchain data and crypto tax software make it possible. Many traders choose to use it as it can reduce capital gains.
Here is an example of reducing taxes using the HIFO method. Bill has accumulated cryptocurrency through three different trades and three different costs. He makes one sale at still another price.
- Bill bought ten coins when it was trading for $40 ($400).
- He bought another ten coins when it was trading for $150 ($1,500).
- He bought another ten coins when it was trading for $80 ($800).
- He sells ten coins when it is trading for $300 ($3,000).
Using HIFO accounting, Bill would set his cost basis for the sale as $1,500 (10 X $150) because that was the highest cost per unit he paid for that asset. The tax math is $3,000 – $1,500 = $1,500 of capital gains.
Taking this one step further, you can also use software scenario modeling. This means using cryptocurrency software that automatically tracks all your transactions, allowing you to use the most beneficial Specific ID method we discussed above. This is particularly beneficial as it removes the margin of error in the process and gives you peace of mind that you’re using the right method to reduce taxes.
Ultimately, your chosen accounting method does not change your total capital gains. It only changes the timing of selling specific coins so that long-term gains are preferred over short-term. Or a method that reduces taxes by selling coins bought at the highest price.
Let Nabers Group Help You Stay On Top of The Crypto Industry
We’ve been investing in bitcoin since April 2013. Nabers Group is by far the most experienced IRS-approved Crypto Self Directed 401k provider in the industry, helping you to structure your retirement account compliantly so you can not only purchase crypto but also hold your own keys. That means you’re in charge of what types of coins you want to buy, and how much, and you don’t have to compromise safety by handing over your private keys to a stranger.
Read more about what we share to educate clients with this educational series.
- Crypto Education Series: Part I – Bitcoin Basics
- Crypto Education Series: Part II – Bitcoin In Your Retirement Account
- Crypto Education Series: Part III – Grow Your Gains Tax-Free with a Roth Account
- Crypto Education Series: Bonus – Bitcoin FAQ
Nabers Group also makes it possible and easy to hold crypto in other tax-advantaged retirement accounts. A Solo 401k enables you to contribute the maximum each year towards your retirement. Both the Roth Crypto Self Directed IRA and the Roth Solo 401k allow holding crypto in a retirement account that allows you to withdraw your wealth tax-free during retirement.
The thought of a looming recession has many people concerned about the possibility of unemployment and layoffs that come with it. Starting a business is the best hedge against a recession. But that’s not the only reason to think about a Solo 401k.
Ongoing fluctuations in the stock and bond markets along with a breakdown of investor confidence in corporate America, are driving the demand for alternative investments with greater choice for retirement accounts. Investors now realize they can invest in crypto, real estate, and other non-traditional assets using their retirement accounts.
Setting up a Solo 401k retirement plan is easy and allows for tax-deductible contributions much larger than an IRA or employer 401k. Importantly, it puts you in control with access to a world of alternative investment options.