This often used tax loophole allows bitcoin holders save big. Bitcoin is down almost 36% from its all-time high in November. But the decline has a positive side effect. Thanks to a loophole in the tax code that allows cryptocurrency holders. To protect their earnings from the Internal Revenue Service.
The Internal Revenue Service recognizes cryptocurrencies as property. Which means that any time you spend, exchange, or sell your tokens. You are filing a taxable event with the government. Always remember that there is a discrepancy between the price you paid for your cryptocurrency. That is known as the cost basis, and the market value of the cryptocurrency. At the moment you spend it. Capital gains taxes may be levied on the difference between the two amounts.
In contrast, an obscure accounting practice known as HIFO (short for highest in, first out) . Can dramatically reduce an investor’s tax liability.
When you sell your cryptocurrency, you have the option of selecting the precise unit. That you want to sell. This means that a cryptocurrency holder. Can choose the highest costly bitcoin they purchased. And use that number to calculate their tax liability for the year. A larger cost basis translates into a lower tax burden on the selling of your home.
However, it is the user’s responsibility to keep track of everything. Therefore meticulous record-keeping is required. Calculations to the Internal Revenue Service (IRS) cannot be proved. Unless a taxpayer maintains accurate records of his or her transactions and cost basis.
This often used since it necessitates meticulous
Shehan Chandrasekera, a certified public accountant (CPA) and the head of tax strategy. At the crypto tax software startup CoinTracker.io. Explains why people don’t utilize it as often as they might. “It needs keeping solid records or using crypto software,” he says. Fortunately, a large number of people are now utilizing this type of software. Which makes this type of accounting really simple. They simply aren’t aware that it exists.”
Maintaining detailed records of every cryptocurrency transaction you make. For each coin you hold. Including when you purchased it and how much you paid for it. As well as when you sold it and the market value at the time. Is the key to successful HIFO accounting practices.
For those who don’t have all of their transactions recorded or who aren’t utilizing the proper software. The accounting system defaults to something called FIFO, or first in, first out. Which means that the transaction records are processed in the order they were received.
As Chandrasekera adds, “it’s not the best situation.”
When you sell your tokens, you are selling the coin that was purchased first. In accordance with FIFO accounting regulations. If you purchased your cryptocurrency. Prior to the cryptocurrency market’s major price run-up in 2021. Your low cost basis may result in a higher capital gains tax payment.
Then there’s the wash sale rule
Experts tell CNBC that combining HIFO accounting. And the wash sale rule might save taxpayers even more.
According to Onramp Invest CEO Tyrone Ross. Losses on crypto holdings are regarded differently from losses on equities and mutual funds. Since the IRS considers them property. Because wash sale restrictions do not applicable. You can sell bitcoin and immediately buy it again. But you would have to wait 30 days to do so with a stock.
This tax loophole allows investors to sell bitcoin at a loss and acquire it again at a lower price. Losses can be used to reduce taxes or offset future gains.
So, a taxpayer bought bitcoin for $10,000 and sold it for $50,000. This person would owe $40,000 in capital gains. This same individual might offset their tax liability by harvesting $40,000. In losses from previous bitcoin trades.
“You want to look poor,” Chandrasekera said.
Depending on their intelligence, Chandrasekera says he sees this weekly to quarterly.
Buying back the cryptos quickly is also important. Buying the drop allows investors to catch the recovery if the digital coin’s price rises.