As the end of the year is approaching, it’s time to take a close look at your portfolio and make smart decisions. Besides enjoying the bull run and keeping track of your crypto wealth, you should check if you have actually fallen into the tax liquidity trap and if you could reduce the tax liability by realizing losses (XRP holders, sorry!). Now it’s your last chance now to review your portfolio and take action by December 31st.
We have summarized the most important tax tips that will save you money, time as well as worries and enable you to start the year 2021 perfectly prepared.
1. Track your tax liability
In crypto-to-crypto trading, gains or losses can be realized for tax purposes, even though there was no cash out in USD. You might need to pay tax on profits, even though your assets are locked in cryptos and the necessary cash is missing. In a worst-case scenario, this could lead to you having to sell your cryptos at an unfavorable rate in order to pay your tax debt. It could even lead to insolvency, as it was the case for many after the last bull run in 2017. We have explained the tax liquidity trap in this article: https://blog.blockpit.io/speculative-tax-trap
So make sure to keep track of your tax liability during the year! There are many situations that lead to taxable income without providing liquidity to cover the tax liability. That is why it is so important to use a trusted tax tracking application during the year, so you can track your tax liability and make sure you have enough cash to cover it.
2. Make use of loss harvesting
Even though 2020 was definitely a year of profits, it could still be that you chose the wrong entry point for some coins and are now in the red. But do not worry, even here you can still get something out. At least from a tax point of view, it is possible to realize losses and thus reduce the tax burden for this year.
You can reduce your tax liability by realizing your book loss, which is the negative difference between the current market value of an asset and your cost basis. In order to do so, you need to sell the crypto asset for other crypto assets or fiat currencies before the end of the year. Therefore it is important to track the profitability of your portfolio and act on time. Even if you want to continue to hold the coins, it may be worthwhile to shift into another coin for a short time.
3. Long term vs Short term
If you hold an asset for more than a year and realize a capital gain, you will enjoy favorable tax rates for long-term capital gains, which are 20 %, 15 % end even down to 0 %, depending on your income. On the other side, if you realize gains from assets held less than a year, they will be taxed as short term capital gains with your ordinary tax rate according to your federal tax bracket. So watch out before selling a coin or token and check the holding period. Sometimes it is better to wait a few days before selling to optimize the tax rate.
Our tip for 2021: Monitoring your tax liability preventively
Always keep an eye on your tax liability during 2021. Taxes are not only due when Bitcoin and other cryptocurrencies and tokens are sold for USD, but also when they are exchanged with each other, or if you receive rewards from Staking or Liquidity Mining. You can build up tax debt during the year without even noticing it or having the cash to cover it. A daily overview of realized and unrealized gains or losses, as well as the holding period of your individual coins, can help you to always make tax-optimized trading decisions.
Use the Blockpit CryptoTax app to analyze your latest transactions automatically via API or blockchain import and access a complete backup of your transaction data at any time.