Planning for next year? 6 strategies for minimizing your 2022-2023 crypto tax bill
Front and center on U.S. tax returns is a pressing question: “At any time during 2021, did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?” If you didn’t think you’d need to report your crypto trades on your tax return, your 2021-2022 tax bill may contain a few unwelcome surprises.
The good news is that it’s never too early to get ahead of next year’s return by considering a few common strategies now. And with some careful planning, you may be able to minimize the taxes you pay on your crypto or other asset sales in 2022.
First things first...
Coinbase doesn’t provide tax advice. This article represents our stance on IRS guidance received to date, which may continue to evolve and change. None of this should be considered as advice or an individualized recommendation, but it’s important to us that our readers have relevant information available to them in the most accessible way possible. Please consult a tax professional regarding your own tax circumstances.
Know your cost basis
Before we dive in, let’s start with an important term: cost basis. Your cost basis is the key to calculating gains and losses on your crypto. Keeping careful records of when you received your crypto — and at what prices — will help you determine which of the following strategies could be best for your unique circumstances.
Your cost basis is generally what you paid to acquire your crypto — including commission and fees — on the day you acquired it. But the exact rules around cost basis depend on how you got your crypto. Your acquisition date is the date you acquired crypto, whether you bought or won it.
Choose the right cost basis method for your situation
If you bought or received your crypto at different times and prices, it’s possible to select specific lots (or groups of assets) to sell, according to your tax strategy. There are a few different ways to get more specific — and more strategic — about which assets you sell, when:
Last in First Out (LIFO): It might be a good idea to sell your most recently acquired shares in order to take a short-term loss. If your most recently purchased shares don’t result in a loss, then look at the shares you purchased first.
First in First Out (FIFO): You might want to sell your oldest shares first if they result in a loss, even if it is long term.
Highest In First Out (HIFO): With this method, you would sell the shares that cost the most, no matter how long you’ve held them.
Because it matters which assets you sell (and in what order), it’s important to keep good records of all of your transactions. If you bought or sold on Coinbase, you’ll be able to see each of your transactions (and its associated cost basis) in your Raw Transaction Report to review with a tax professional.
Consider how long you’ve held your crypto
If you’re looking to minimize capital gains tax, it could be a good idea to sell assets that you’ve had for more than a year first. Why? In general, if you hold your crypto for more than a year, your gains will be taxed at a lower, long-term capital gains rate. If you held your crypto for one year or less, you’ll be taxed at a higher, ordinary income tax rate.
As you approach the end of the year, take a look at whether the realized gains of a sale will push you into a higher tax bracket. If they do, you may want to wait to sell. While the gain itself may be taxed at a lower rate, your overall adjusted gross income may be taxed at a higher rate, wiping out your capital gains savings.
Keep an eye on your losses
Your crypto losses aren’t all bad news — you can sometimes use them to your advantage. If you have more capital losses than gains, you can use up to $3,000 a year to offset other gains. This amount carries over to future years, indefinitely. So a considerable loss might actually benefit your future self.
It’s important to note that losses have to be used to offset capital gains first. And when you’re using capital losses to offset capital gains, you have to offset gains of the same type first:
Long-term losses offset long-term gains
Short-term losses offset short-term gains
So if you have more short-term losses than short term gains, you can use the excess short-term losses to offset your long-term capital gains. If your losses exceed all of your gains for the year, you can use up to $3,000 to offset capital losses, this year or in future years.
This rule is half of a well-known strategy called tax loss harvesting. This happens when you sell underperforming assets (whether stocks, bonds, or crypto), use your losses to offset current or future capital gains, and then use the proceeds from the sale to purchase another asset. This way, you can offset your gains, and stay invested.
When you're looking for tax losses, focusing on short-term losses yields the greatest benefit because you have to use them to offset short-term gains (the gains taxed at the highest rate) first.
Many financial advisors do tax-loss harvesting for you across stocks, mutual funds, and other assets in taxable accounts. But you should speak with a tax professional before trying it yourself.
Look ahead before realizing gains now
Because of capital gains rules, you’ll generally see a lower tax bill if you hold your crypto for at least one full year before selling. The keyword here is generally, because there’s a bit more to it than choosing to hold or sell in any given year. You might do your future self a favor by considering a few more factors before making a sale, like whether you’ll have more or less income in future years — or whether you’re holding too much of a given asset.
Tax gain harvesting is a strategy for selling assets that are performing well, and then using the proceeds to buy back those assets or purchase new ones. You might consider tax gain harvesting later this year if you have a lot of capital losses on assets you sold but don’t have gains or income to offset — or if you know that you’ll fall into a lower tax bracket this year.
Why would you do this? You could end up in a lower tax bracket if you’ve taken significant time off work, switched careers, or gone back to school this year. If you expect your income will go back up, selling a crypto that’s appreciated a lot this year may not impact your tax bill as much as it could in future years. And purchasing new assets can keep you invested, reset your cost basis (potentially minimizing gains in future years), or help you rebalance your portfolio.
As with tax loss harvesting, it’s always a good idea to talk with a tax professional before trying out a new strategy.
Try donating to charity
Had a good year? Even if you take the standard deduction on your tax return, it may make sense to donate appreciated crypto — with unrealized gains — to charity instead of cash. Instead of selling your crypto at a gain, you can avoid paying capital gains tax on the sale and support a cause at the same time.
If you itemize your deductions, you can potentially lower your tax bill by contributing to qualified organizations. If you regularly donate to charity — and your itemized deductions don’t exceed the standard deduction — you could try applying two years worth of donations into one tax return to take advantage of itemized deductions, then use the standard deduction the next year.