A few disclosures before we jump into some more strategy for crypto currency tax
1: I am not a doctor
2: As with anything that is written online check with your tax professional or financial planner to see if it will make sense for you and your needs, or hire me to create a formalized plann based on your situation.
3 I do have holdings in cryptocurrency.
4: Make sure you know what you need for short, medium, and long term money before making any financial decisions.
In most of the cases I have had talking with crypto investors, of panic selling to a huge short term gain here in 2017. There are things that we can do to reduce tax, some cost some money, some require some pre-planning, and some are on the frontier of the tax code as the IRS has given us sparse solid direction as to the tax treatment of crypto currency. All of these options have limitations and may not make sense for all traders
Strategy #1 The Panic Sale and Reinvest – Low Tax Risk
If you bought and sold within a year, and sold for more you bought, you will have a short term capital gain taxed at the rate of your ordinary income. If you did not pull any money out of the market but turned around and reinvested it all back into crypto currency, you have two options: Keep it in the market long term paying out of pocket for your taxes, or sell on or before Dec 31st to potentially have additional gain or worst case scenario short term loss that will offset some of your gains. This strategy only works with those that did not take a large chuck out of the market and put it into their pocket and for people who do not need to liquidate the investments for money needs in the next 6 months.
Strategy #2 Sell Crypto, Invest in Personal Businesses/ Real Estate Investing- Low/ Medium Tax Risk
If you are already own your own business, or have thought about starting a business, having the extra cash from crypto sales can allow you to buy assets that can be expensed out in the current tax year to create a loss or to purchase real estate that can have a loss on your tax return through items like depreciation. With businesses, make sure there is what the IRS considers a profit motive per Elizabeth Giles V Commr. Memo 2006-15 2005-28 (Long case short dentist had a practice that made significant money, but a horse “business” that did not display a motive for businessper the tax court and lost the loss she tried to deduct). The biggest take away from this is that you should be applying the duck rule (Walks, Smells, Sounds, etc.) and making sure that you are documenting your business with stationary, client meeting logs, and a business plan that you are updating yearly to show there is some thought in the running of your business. If you are not showing growth in 3 out of 5 years, you will be at a greater risk of having some extra scrutiny from the IRS. You can purchase items that would be reasonable and necessary for your business (so no buying a lambo and claiming it’s for your courier service that only delivered one package for your neighbor). Once you have found property that passes, you can take section 179 depreciation deduction or anything under $2,500 you can expense via special election on your tax return. Now, if you ever sell the item for a gain on its basis you can have depreciation recapture or capital gains and there are some limits on how much you can take depending on the asset class and the total amount of depreciation claimed in the year.
A similar path can be taken with real estate, but it would require you to divest from Crypto currency and to have total adjusted gross income (AGI) for the year of less than $100,000 for full active real estate loss deduction of $25,000 or it will phase out and be reduced completely when you hit an AGI of $150,000. Real Estate is depreciated out over a significant period of time (27.5 years for residential rental) but if you do a cost segregation of the property you can accelerate depreciation on appliances and land improvements like fences and decks depending on the type of property. The strategy here would be to use the gains from the sale of your crypto to pay the down payment on a rental and collect rents to pay the bills and make some money. You can pick up a loss and if you get to the point that you are ready to sell that piece of real estate, you could potentially qualify for a 1031 like kind of exchange if you use the capital gains on the sale to buy your next rental property within 45 days or having it held in escrow buy a company that specializes in 1031 exchanges.
There are many other strategies that I will release on a weekly basis, so keep an eye out for those. The next article will talk about using IRAs and switching from the investor status to dealer status for tax purposes and some higher level planning items. If you want to schedule a phone consult free of charge please shoot me an email, and I will be happy to talk with you about your situation free of charge.