I wanted to share with this sub some information regarding how you may be able to raise your taxable base in some of your bitcoin holdings. This dawned on me a week ago when I saw a comment on a post discussing the difference between short term and long term capital gains tax rates, and after discussing with my tax accountant, I wanted to share with the sub for broader knowledge sharing.
Disclaimer: Please contact your tax preparer/accountant before you proceed with anything in real life. Make sure you understand the capital gains rules for yourself and confirm with your tax preparer/accountant.
Some here may know and understand that when you sell your bitcoin it creates a taxable transaction. As the US Government recognizes bitcoin (and other cryptos) as property, and not a currency, you need to pay taxes on the difference between what you paid for your BTC and what you sold your BTC – if it has gone up in value. These taxes are referred to as “Capital Gains” taxes – similar to gains on the sale of stocks or other assets. There are two types of capital gain taxes depending upon how long you have held the underlying asset (i.e., bitcoin) – these include Short Term and Long Term. If you have held the bitcoin for less than one year (365 days) then you will pay Short Term Capital Gains taxes – which are taxed at your marginal rate (like additional normal income). If you held your bitcoin for greater than 1 year, then you will pay Long Term Capital Gains taxes – which are taxed at varying levels depending upon your level of income.
Tax Rates for Long-Term Capital Gains in 2021
| Filing Status | 0% | 15% | 20% |
|---|---|---|---|
| Single | <$40,400 | $40,401-$445,850 | >$445,850 |
| Head Of Household | <$54,100 | $54,101-$473,750 | >$473,750 |
| Married Filing Jointly | <$80,800 | $80,801-$501,600 | >$501,600 |
| Married Filing Separately | <$40,400 | $40,401-$250,800 | >$250,800 |
How to use Capital Gains to your advantage
You will notice that for Long-Term Capital Gains there is a 0% tax rate – meaning that you will pay ZERO income tax on any gains on the sale of your bitcoin/assets as long as you are under the taxable income thresholds noted above (and in the link provided). As long as you have held your bitcoin for more than 1 year – you could sell your position, buy it back immediately afterward and you’d pay no income tax on the sale, but you would have increased your taxable base in your BTC – meaning that in the future you would pay less income tax on the sale of your bitcoin.
Other important items to note
- Taxable Income – you need to understand taxable income vs. your salary/total hourly wages. The difference between these two includes: (a) medical insurance premiums, (b) 401(k)/403(b) retirement contributions, (c) Health Savings Accounts (H.S.A.) contributions, (d) your standard or itemized deduction, (e) etc.
- You will only be able to avoid long term capital gains taxes on the amount of bitcoin sold valued between your taxable income and your respective income threshold. (see example below)
- The standard deduction for 2021 is $12,550 for Single/Married Filing Separately, $19,400 for Head of Household, and $25,900 for Married Filing Jointly. (source: https://www.investopedia.com/irs-announces-tax-brackets-and-other-inflation-adjustments-for-tax-year-2022-5209190)
- If you are able to itemize your deductions, then even more power to you because you’ll be able to drop your taxable income levels even lower than those who use the standard deduction – but MOST people qualifying for the income levels above will not be able to itemize – it would be a unicorn of a situation most likely.
Illustrative Example
Jim is married to Millie. They both have jobs. Jim makes $50,000 and Millie makes $15,000. Jim pays for medical insurance and contributes to his 401(k), where Millie does not. Their paystubs (not including federal/state income taxes or FICA) total to the following:
| Jim | Millie | |
|---|---|---|
| Salary | $50,000 | $15,000 |
| Medical Insurance Premiums | ($2,000) | $0 |
| 401(k) Contributions | ($4,000) | $0 |
| Taxable Income | $44,000 (A) | $15,000 (B) |
| Projected Total Income | $59,000 (A+B) | |
| Less: Standard Deduction | ($24,000) | |
| Projected Taxable Income on Tax Return | $35,000 (C) | |
| LT Capital Gains Threshold | $80,800 (D) | |
| Potential Income For 0% Capital Gains | $45,800 (C-D |
Let’s assume that Jim and Millie were early adopters to Bitcoin and they purchased 3 bitcoins back in July 2015 at $300/coin (total tax basis of $900 - $300 x 3 coins). Today, those 3 bitcoins are worth $174,000 ($58,000 spot x 3 coins). Based on their current income levels (noted in the table above), Jim/Millie could sell 0.789 bitcoin for a profit of $45,800 and pay 0% taxes on it. If they were to sell, and then instantly rebuy their bitcoin, they could eliminate $45,800 of income that they’d ever have to pay taxes on in the future, as the taxable base on that .789 bitcoin would now be $45,800, rather than $300.
This also raises their taxable base for their entire bitcoin holdings from $900 ($300 x 3 BTC) to $46,425 ($300 x 2.211 BTC + $58,000 x 0.789 BTC). It raises the average taxable base for each of their 3 BTC to $15,475 ($26,425/3) from their original $300 purchase price.
The end result of all of this was that they kept the same amount of BTC, but were able to increase their taxable base without ever having to pay any income tax on the sale – and allows them to pay less income tax on any eventual sale they decide to do. The benefit also works in the favor for if the price of BTC falls dramatically in the future as it will allow for a capital loss opportunity since you have a higher tax base. An example for that is below:
- Jim/Mollie bought 3 BTC at $300/each.
- Jim/Mollie sell 0.789 BTC at $58,000 (taxable basis $45,800) and then rebuy immediately, raising their overall tax basis from $900 to $46,425 for their entire BTC portfolio (for which they pay no income tax).
- BTC then falls to $15,000 366 days after their purchase (must be over 1 year)
- Jim/Mollie can sell their 0.789 BTC and recognize a $30,375 capital loss, which can be recognized $3,000 at a time in each subsequent income tax filing until the full loss is realized – which reduces your ordinary income (i.e., salary/wages) and reduces your taxes – that’s 10+ years of reduced income tax in this example.
edit: I originally thought BTC was a "security" and not "property". Thanks to u/explosiveplacard for correcting me on this and as such the Wash Sale rules do not apply - which is even better for BTC investors as you can sell your BTC at a loss, harvest those capital losses (to offset capital gains or up to $3,000 in ordinary income) and immediately repurchase your BTC again essentially not losing any real time position.
- Jim/Mollie would have to wait 31 days to repurchase their 0.789 BTC to avoid any Wash-Sale rule impacts (i.e., essentially you can’t sell to recognize a loss and immediately repurchase it – you must allow for 30 days to provide a buffer for tax purposes, otherwise people would be selling and repurchasing their assets immediately to avoid paying taxes).
Conclusion:
You should take a good look at the capital gains rules, contact your tax preparer/accountant (which I have and he has agreed with my understanding of the rules), and assess if your income levels allow you the opportunity to take advantage of the 0% capital gains tax rate. It really is a solid win all around if your income levels allow you to take advantage of it.
Hope this helps some people avoid paying income taxes on their BTC/cypto holdings - LEGALLY!
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