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2023 Crypto Tax Planning Overview with Year-End Ideas for Individual Investors

Business woman using tablet with cryptocurrency bitcoin link network concept

Crypto has been around for over a decade now but has recently exploded into the mainstream financial profiles in the past couple of years as a way to make a quick and sizable return on investment and while the risk was high the potential profits attributed to the investment made it worthwhile. Within the past year we have seen a very volatile and risky marketplace arise due to major bankruptcies and changes that have frankly put investors on edge. 

We are now a few years removed from that initial "boom" in the marketplace so where are we now? Has the IRS caught up with consumers? What can we expect going forward and how can we mitigate our liabilities connected to Cryptocurrencies? These are just some of the constant questions that surround crypto and its counterparts. Understanding how these transactions are taxed and how we can use planning to our advantage is crucial to mitigating our liabilities in this volatile marketplace.

Crypto Tax Rate

Crypto as viewed by the IRS is a capital property subject to your normal short-term (10%-37%) and long-term (0% - 20%) gains which are based on your income tax bracket for the taxable year. All earnings from crypto investments which include mining, staking, or payments received are taxed at the ordinary income rate which will also vary on which income bracket you fall into.

Crypto Taxable Transactions

Transactions dealing with cryptocurrencies can become complicated and confusing very easily given the implications and situations surrounding these taxable events. Here is an overview of some of the most notable transactions we run into as a firm and how they are treated per the current IRS standards and rules:

Crypto Taxes on Trading and Selling:

The IRS recognizes the following as taxable events subject to capital gains tax:

  1. Exchanging a digital asset for another digital asset (I.e., ETH for BTC)
  2. Trade or exchanging a digital asset for real tangible property or goods (I.e., ETH for a Car)
  3. Any other relinquishment or disposition of a financial interest in a digital asset
  4. Sale of a digital asset for fait (i.e., ETH to USD)

The above transactions will be taxed based on your income tax bracket and whether they are classified as long-term or short-term gains.

Crypto Capital Losses

The IRS considers cryptocurrencies as property therefore we can deduct up to $3,000 on any digital asset losses incurred during the year (or future years if applicable) by offsetting capital gains or reporting as an income tax deduction. Any amount over $3,000 will be carried forward to future years.

Crypto Tax Implications on Stolen or lost assets (including bankruptcy)

Unfortunately, the IRS has clarified that only losses incurred from a federally declared disaster are eligible for deduction on Form 4684 (Casualty and Theft). Currently, there is no clear path to recoup losses incurred by stolen or lost digital assets.

In 2022, We saw several cryptocurrency exchanges file for bankruptcy which was deemed catastrophic for the digital market. Taxpayers can deduct the losses once the bankruptcy is settled and your crypto is deemed worthless, you can offset your crypto based on what you paid for the asset and treat it as a capital loss.

As laid out in a Chief Counsel Advice Memorandum (CCA 202302011) released in January 2023, The Digital asset must be deemed worthless for the taxpayer to take a deduction under section 165. Even if the taxpayer has incurred a significant decline in value due to unforeseen circumstances (i.e., Bankruptcy) the digital asset is believed to still have value and therefore cannot be recognized as a loss sustained under section 165 worthlessness/ abandonment of the cryptocurrency.

Unfortunately, there is no one-size fits all with stolen or lost assets within the crypto market and for that it is important to note that every individual circumstance may be different, and each investor needs to consider the facts and circumstance around their respective case when determining deductibility.

NFT's (Non-Fungible Tokens)

A new guidance (IR-2023-50) from the IRS was provided in March 2023 regarding the taxable treatment of NFTs. It changed the status of NFTs from capital property to a collectible when it was deemed necessary by the IRS. By using a "look-through" analysis, the IRS will determine if an NFT is a collectible with each sale in the context of tax code section 408 by determining whether the associated right or asset meets the definition of a collectible. Depending on the classification of the NFT, it can be expected to be taxed at a maximum rate of 28 percent.

Mitigating Liabilities Concerning Crypto Taxes

Crypto transactions are no different from other forms of income or cash flow, and we cannot absolutely avoid them from being taxed, but we can mitigate and reduce them by understanding the marketplace and planning so that the overall liability of crypto transactions can be significantly reduced.

Tax loss harvesting, prioritizing long-term transactions, cryptocurrency donations, gifting, utilizing digital asset software, and executing large sales in years of reduced income are just some ways we can reduce overall liability. It is important to note that in regard to tax loss harvesting, there are currently no wash sale rules within the crypto space which we can utilize as a way to accelerate any losses in periods of increased income or gains. It is imperative that investors plan and have contingency plans in place as we navigate through this volatile marketplace.

The most important thing you should do when investing in the digital market is to keep track of all your investments. It can get confusing when buying large amounts of crypto due to their volatile nature. Each unit is its own entity which we can strategically use to our advantage to produce the smallest gain possible on the sale of an asset like a stock. Along with knowing which units you are selling, we can use various accounting methods (FIFO, LIFO, and HIFO) to determine cost basis to further decrease our reported gain.

As a final point, think about whether you have a similar asset that can be sold at a loss to offset the gain on a digital asset sale, or whether you have a carryover from the previous year to use. By looking ahead and strategically planning your sales, we can mitigate your taxable liabilities immensely.

For more information about 2023 Crypto Tax Planning, reach out to us today.

Ian is a staff accountant in our Akron office.

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