As Bitcoin and cryptocurrencies have become mainstream, governments have taken notice by implementing regulations to control the trading of crypto. Some countries like China have completely banned crypto, while others have placed partial bans by restricting financial institutions from associating with crypto.
The majority of countries allow the trading of crypto but have placed regulations, including making any gains on cryptocurrencies taxable.
If you’re in a country that allows the transacting of Bitcoin, chances are you’re required to pay taxes on Bitcoin. In the US, the IRS issued an update I.R.S. Notice 2014-21, classifying cryptocurrencies as property, meaning they incur the same U.S. federal tax consequences as property transactions.
In Canada, income from Bitcoin and other crypto is taxable as it’s categorized as business income or a capital gain.
In the European Union, cryptocurrencies are not subject to taxes yet. However, member states are in discussion to introduce taxation in the future.
Countries with some form of taxes on cryptocurrencies, either income tax, VAT, or capital gains tax include:
- Costa Rica
- Czech Republic
- El Salvador
- Hong Kong
- New Zealand
- Russian Federation
- “Saint Kitts and Nevis”
- South Africa
- South Korea
- United Arab Emirates
- United Kingdom
- United States
Note: Keep in mind tax laws in these countries can be updated at any time, so do your research before investing in crypto.
You are required to pay taxes on any realized gain on your Bitcoin investment. For example, if you bought 1 Bitcoin at $20,000 and the price right now is $40,000, it means you have a gain of $20,000, which is taxable.
However, you’re not going to be taxed until that $20k gain is realized. Events that can trigger taxation from realized gains include:
- Selling your Bitcoin in exchange for traditional currency (dollars).
- Trading your Bitcoin for another crypto, e.g., ethereum.
- Paying for goods and services with crypto.
So if you bought 1 Bitcoin at 20K, gains would be realized if:
- You sold 1 BTC for 40,000 – the taxable gain would be $20,000.
- You used 1 BTC to buy a $30,000 car – the taxable gain would be $10,000.
- You exchanged 1 BTC for $35,000 worth of ethereum – the taxable gain would be $15,000.
Capital gains are divided into two categories:
- Short-term gains: Short -terms gains refer to assets held for a year or less. Taxes on such gains tend to be higher than taxes on long-term gains.
- Long-term gains: Long-term gains refer to assets held for more than a year. Any gains realized from selling Bitcoin held for more than a year would be taxed at a lower rate.
Also, if you receive Bitcoin as payment for goods and services, as a reward, or through mining, you’re required to record the value of that Bitcoin when received and report that in your income.
Keep in mind the rate at which your capital gains are taxed is also affected by your marital status and income.
Hiding any cryptocurrency gains from the IRS is very risky, and if you decide to do so, it’s at your own risk.
The IRS uses various software to detect tax cheats and requires crypto exchanges, crypto atm operators, and institutions involved with crypto to report transactions over a certain threshold.
The only reasonable way to avoid tax is by exchanging your BTC for cash, but this would present several constraints such as lots of travel to find a willing buyer and attracting scrutiny from your bank when depositing huge sums.
An IRA (Individual Retirement Account) is one of the best ways to avoid paying taxes on your Bitcoin investments. IRAs allow you to make a variety of investments including stocks, ETFs, bonds, certificates of deposits, and mutual investment funds.
Before investing in Bitcoin, you’ll want to get a self-directed IRA, a special type of IRA that allows you to invest in more investments such as cryptocurrencies, real estate, commodities, private placements, which would have otherwise been restricted in a traditional IRA.
Self-directed IRAs are available both as a traditional IRA or Roth IRA. Traditional IRAs allow you to make tax-deductible contributions, but you’ll have to pay taxes during retirement as the withdrawals will be taxable.
Roth IRAs on the other hand, require you to pay taxes on your contributions, but the contributions and earnings will be withdrawable tax-free during retirement.
So if you buy Bitcoin within a traditional IRA, and it rises in value, hence making you a profit by the time you retire, the taxes on the gains would be deferred till withdrawal. However, buying BTC within a Roth IRA will allow you to withdraw your gains tax-free.
Another way to invest in Bitcoin without paying taxes on your gains is by purchasing offshore Private Placement Life Insurance.
The main difference between a traditional life insurance policy and an offshore Private Placement Life Insurance is that the former incurs taxes while the latter is more tax-efficient.
Compared to IRAs, which have contribution limits and distribution requirements, offshore life insurance policies allow you to contribute and distribute your investments as much as you want.
If you wish to cash out your investment, you can close down the offshore private placement policy and enjoy tax breaks the same as a traditional IRA. Holding the policy till you pass away allows you to transfer your Bitcoin investment to your heirs tax-free, with benefits same as a Roth IRA.
Your heirs will then receive your coins at the value at the time of transfer, so they won’t have to pay tax on the gains achieved during the life of the offshore Private Placement Life Insurance.
However, keep in mind this method is only suitable if you plan to make huge investments in Bitcoin or any other cryptocurrency. Most Offshore Private Placement Life Insurance Policies require a minimum of $1.5 million or $2.5 million.
When you invest, you can make a profit or a loss. For example, if you buy BTC at $30,000 and it tanks to $20,000, you’ll have a potential loss of $10,000. If it goes up in value, the difference between the new value and the basis is your profit.
Basis refers to the initial value of an investment, so in this case, it would be $30,000.
In the US, losses from investments can be used to offset gains from another investment. This is known as tax-loss harvesting, a strategy that you can use to your advantage to reduce the amount of tax payable.
The US tax code allows you to use a maximum of $3,000 as a loss to offset any other income every year. Any remainder can be rolled over to subsequent years until depleted.
Also, capital losses can be used to offset capital gains.
For example, if you bought Bitcoin and held it short-term and the investment resulted in a loss of $3000, and you made another long-term investment of Bitcoin and made a gain of $2,000, you’d end up with a net $1,000 short-term loss.
Cash Out During A Low-Income Year
In the US, your tax rate depends on your income, marital status, or head of household status. Regardless of whether your gains are realized from short-term or long-term investments, your tax bracket will depend on these factors.
Low-income earners are placed in lower tax brackets, while those with more income are in higher tax brackets.
To pay a lower tax on your Bitcoin profits, you can time your cashout to coincide with the year in which your income is in a lower tax bracket hence a lower tax rate.
You can avoid paying taxes on your Bitcoin by gifting it to a family member or friend. In the US, you can gift BTC with a maximum worth of $16,000 tax-free, per recipient annually without disclosing it to the IRS. This means you can gift your cousin $16k, your son $16k, your aunt another $16k, etc.
If you gift more than $16,000 in a year to any person, you’ll have to disclose it to the IRS by filing a gift tax return.
However, you won’t pay a gift tax until you exhaust your lifetime exclusion of $12.06 million.
The $16k limit is per person, so you and your spouse combined can gift up to $32,000 worth of crypto to any person.
You’ll have to disclose to the recipient of the gift your basis on the BTC as they’ll have to pay tax on any gains above your basis. However, the tax rate will likely be less than if you paid it yourself.
Ideally, you should gift the BTC to someone in a lower tax bracket to reduce the amount of tax payable later on the gains, let’s say your youngest sibling who just started his/her first job.
Every citizen of the US is required to pay taxes on income or capital gain regardless of whether they are living in the country or abroad.
An exception to this rule is Puerto Rico. Income or gains realized in Puerto Rico are exempt from US taxes under IRC Section 933.
Although Puerto Rico is a territory of the United States, it is a self-governing state meaning it’s free to set up its tax laws.
The territory set up Act 20 and Act 22, which offer some enticing tax deals. For companies that establish and expand their export services in Puerto Rico, their profits will only be taxed at 4%. So if you establish a company in Puerto Rico and invest in crypto, your gains will only be taxed at 4%.
Act 22, on the other hand, aims to attract new residents to the territory by offering new bonafide residents a zero-tax rate for any short-term and capital gains. This means you can invest in crypto and take home the entirety of your gains.
To become a resident of Puerto Rico according to the IRS:
- You must spend at least 183 days of the tax year in Puerto Rico.
- You spent at least a combined 549 days in Puerto Rico in the current and previous two tax years.
- Spend a maximum of 90 days in the mainland US throughout the tax year.
- You can only earn a maximum of $3,000 in the mainland US.
- You must not maintain significant connections in the US throughout the tax year.
Note: Spending even a few hours in Puerto Rico can constitute a day spent on the territory. In addition, 30 of the 183 days mentioned above can be spent elsewhere, you don’t have to be in Puerto Rico, but you must not set foot in mainland US.
If Puerto Rico is not your cup of tea, you can choose to relinquish your US citizenship and move to countries with little to no tax on capital gains from cryptocurrencies. These may sound extreme, but if you are planning to make huge investments, it might be worth it if you’re so determined to keep your gains.
You’ll need a second passport before giving up your US citizenship.
Countries with no tax on cryptocurrency gains include:
- Cayman Islands
- El Salvador
- Puerto Rico
Note: Keep in mind tax regulations in these countries may change anytime so do your research before relocating.
If you’re not interested in cashing out your Bitcoin investment during your lifetime, you can use it to build generational wealth and in the process, avoid paying taxes on any gains.
For this method to work, the value of Bitcoin should skyrocket over time so that you can pass a substantial amount to your heirs.
Once you die and your assets are passed on to your heirs, your BTC will receive a step-up basis. This means the basis of the BTC will be the market value at the time of your death.
So if they sell the crypto immediately, they won’t have to pay tax since the basis will be the same as the selling price. If they decide to hold the BTC, capital gains will be calculated with the basis with which they received the crypto (time of your death), not when you bought it.
You can avoid paying taxes on your BTC if you donate it to a qualified charity and itemize it in your deductions.
You can deduct the fair market value of the BTC, and you won’t be required to pay tax on any gains.
The amount you can deduct will vary depending on the type of contribution and the organization.
Matters concerning the payment of taxes can be complex. Even the best of investors rely on the services of professionals. The IRS cannot issue specific advice to individuals due to the wide range of regulations and circumstances involved in the tax process.
That’s why you need a seasoned professional who knows the ins and outs of filing taxes to help you report correctly and avoid potential fines or penalties.
Written by Edmond K.