The Hidden Crypto Tax Strategy Saving Investors Thousands

Crypto investors can save thousands of dollars in taxes using some simple strategies. And all these strategies are completely legal. All you have to do is plan better and follow some easy steps that can help you save substantial money.

Crypto tax in most parts of the world can almost kill degens, ‘figuratively.’ FYI, the short-term capital gains tax rate on crypto transactions can go up to 37% in the US. That’s more than one-third of the transaction. Then, additional income tax applies to certain crypto transactions.

However, using these crypto tax loopholes, you can massively add to your profit. So, in this guide, we’ll understand everything, right from the basics to the most advanced crypto tax strategy.

Understanding Crypto Taxes

Before getting to the loopholes, it's important that we first understand how taxation actually works in crypto. The classification of a transaction as a certain type of income varies from country to country.

In the US and most countries, cryptocurrency is treated as property.

This means selling crypto will trigger capital gains taxes, similar to a company’s shares that you purchase from the stock market. On the other hand, some transactions, like income received from crypto mining or airdrops, are treated as ordinary income.

The distinction between the two is important because the rates for these events are different. This detailed table will help you understand the differences between the two:

Are Crypto Tax Loopholes Safe to Use?

A balanced crypto tax strategy can save you a lot of money without breaking the law. You must understand that DeFi is still a market that is evolving and awaits much regulatory clarity.

As of now, the IRS allows certain transactions that can be used to lower the tax burden. So, it is not at all tax evasion, it’s just smarter planning.

The Core Crypto Tax Loophole

Tax loopholes may sound fancy, but they are mostly a great crypto tax saving opportunity based on tax optimisation, classification, and timing. Here are some key tactics that you can use to save up on crypto taxes.

1. Long-Term Holding

As mentioned earlier, long-term capital gains are taxed at a lower rate than short-term gains. So, delay disposals until you hit the one-year mark. The US tax system even encourages this.

Sell after a year and pay at most 20% federal tax instead of up to 37% in the case of STG. So, if you’re at 10 or 11 months, it often makes sense to wait a little to qualify for long-term capital gains.

2. Specific Identification

When you decide to sell coins, pick the ones with the highest cost basis (LIFO/HIFO) from that wallet. This specific identification method can minimise gains, which means less tax. But remember, make sure you have detailed records of purchase dates and amounts.

3. Jurisdiction & Entity Stacking

Holding coins in the right place at the right time can make a big difference. U.S. citizens are taxed worldwide, but living in a crypto-friendly country or using an offshore entity can save you taxes.

For instance, Puerto Rico, under Act 60, taxes crypto gains at 0% for bona fide residents. Moving before your holding hits one year could also change the place where the gain is taxed.

4. Reclassifying Income

Sometimes you can change how earnings are taxed. For instance, Under tax provisions the original income received from staking is considered ordinary taxable income. It is better to hold your staking income for more than a year.

Instead, when you sell the coin, it will be treated as long-term capital gains. The profits will be taxed at a lower rate, and the losses can be offset against the income from staking.

How can crypto investors turn losses into tax savings?

Crypto investors can save taxes by tax-loss harvesting. If you have any crypto loss positions, you can sell them to book a capital loss. That loss offsets any capital gains, and even up to $3,000 of ordinary income each year.

This is a very popular crypto tax loophole.

Another brilliant strategy is the wash sale rule. In traditional finance, the rule says that you cannot claim a loss if you purchase the same asset within 30 days. Since crypto isn’t under the wash-sale rule, you can immediately repurchase the same asset and still claim the loss.

This means you can buy BTC today, sell it at a loss by the end of the day, and still repurchase the same tomorrow and claim a deduction. This popular Bitcoin tax loophole can save thousands by eliminating profits.

It is legal for now, but lawmakers are keen to make rules around it.

Crypto Tax Strategy #1: DeFi Loopholes

Decentralised finance has its own ways to operate. Sometimes, you can get a little creative and strategic to save up on crypto taxes. A few interesting ways you can do so:

1. Crypto-Backed Loans

Taking a loan against your crypto assets is not a taxable event. You pledge coins as collateral and receive cash in your account. Since you haven’t sold anything, you owe no capital gains tax.

However, selling coins for cash would trigger tax. The IRS treats this like any personal loan, not income. You pay interest on loans, which can be deducted from the total income in the year, which will result in lower taxable income.

But remember, if the value of the crypto assets drops substantially, the loan platform may sell them at a point to recover its collateral. That will be a taxable event for you.

2. Token Wrapping

Wrapping coins, for instance, BTC to wBTC, is a grey area. Most tax professionals treat it as a crypto-for-crypto exchange, causing gains or losses. But some argue that it’s merely converting to an equivalent token, so it is non-taxable. But, in both cases, you must calculate the FMV, cost basis, and other important details.

3. Liquidity Pool Share Accounting

Joining a DEX liquidity pool like Uniswap is akin to swapping assets. If you deposit Token A and B, you’re essentially exchanging some of each for LP shares, so you realise any built-in gains.

Later, when you withdraw, you get back A and B, possibly more of one than the other due to fees and rewards. The difference from your original basis is taxable. This again is a complex taxable event which requires a lot of tracking and documentation.

4. Rebase tokens & Synthetic Assets

Tokens that auto-rebase, i.e., increase your token count, result in taxable income. Synthetic assets like options or on-chain derivatives will likely generate capital gains on the trade. Losses from rebase tokens can be used to offset other capital gains.

Crypto Tax Strategy #2: International Structures Most Investors Overlook

As discussed earlier, taxes on crypto transactions vary in every country or domicile. So, you can also use these international structures to lower your tax bill.

Territorial Tax Systems: Some nations only tax income sourced within their geographical ambit. For instance, moving residency to the UAE or Singapore means no tax on capital gains. Similarly, Portuguese residents currently enjoy no tax on crypto gains. Malta and Germany also have favourable treatments if some key conditions are satisfied.

Puerto Rico (USA): U.S. citizens can move to Puerto Rico under Act 60. There, crypto gains are taxed at 0% for bona fide residents. This is a very big deal for crypto traders and long-term investors.

Offshore Entities: An offshore entity in a crypto-friendly jurisdiction can lower and defer tax for non-US owners. For example, forming an LLC in a zero-tax country like Cayman or the Bahamas can keep gains untaxed until profits are sent back to the US. Several crypto investors and traders have moved to the Bahamas in the recent past.

Migrating Before the 12-month Period: If the investors migrate to a location that offers benefits on crypto taxation before the 12 months of the asset acquisition, it changes where the gains are to be taxed.

US Exit Tax: The IRS imposes an exit tax on those who give up their green card or US residency. So, taxes will be imposed on the fair market value of the holding assets on the day before expatriation.

Crypto Tax Strategy #3: Entity-Based Structuring

Let’s understand how the taxation rules differ for different kinds of entities.

There are pros and cons to each entity. Generally, these entities require high documentation and mandatory filings, which can increase your reporting costs.

Then, there’s IP Licensing, i.e., if you create crypto software or IP, transferring it to an entity in a tax haven, places like Luxembourg, Singapore, etc., and charging licensing fees can defer or reduce tax.

Strategy #4: The Multi-Quarter Tax Optimisation Process

Tax planning doesn’t happen only in April. Do it quarterly:

• Regular Reviews: For each quarter, prepare a tax report. Identify big realised gains so far, and potential losses you can harvest. Early awareness lets you take action before things get complex at the year-end.
• Rebalancing with Tax in Mind: If your portfolio shifts, decide when to rebalance. For instance, if BTC has doubled in price but you need stablecoins, selling some BTC now will incur tax. If the market later dips, perhaps wait for losses to offset.
• Tax Loss Harvesting Checkpoints: Don’t wait for December. If a crypto tank occurs at any point in time, sell the loss-making assets then and repurchase to lock in losses that can offset gains from earlier in the year.
• Estimated Tax Adjustments: The IRS requires quarterly estimated payments if you expect to owe >$1,000. Crypto investors often forget this. If you suddenly realise a gain, increase your 1040-ES payment to avoid penalties. Conversely, if you harvest a large loss, you might reduce payments.

Spreadsheet Examples

Here are some calculations that may help you understand the concepts better:

Here, the long-term capital loss from selling ETH is being offset against BTC. Also, if BTC were held for about 4 more months, it would have been taxed at a much lower rate, i.e., 20% max compared to STG taxes, i.e., up to 37%.

Tax-Loss Harvesting Example:

Suppose you have $10,000 unrealised loss on some altcoin named Z. You sell it in December for $8,000, down from a $18,000 cost basis. Also, you have a total realised gain of $15000. Here’s how you can save taxes on the same:

Using tax loss harvesting, you now pay taxes only on $5000. Suppose your capital gains tax rate is 20%. You save $2000 in taxes.

Professional Directory

Crypto CPAs (US)

• CryptoTaxAudit – https://www.cryptotaxaudit.com/ – USA
• Camuso CPA – https://camusocpa.com/ – USA
• Alpine Mar (Crypto CPA Services) – https://alpinemar.com/ – Florida, USA

Law Firms (US & International)

• Holland & Knight LLP – https://www.hklaw.com/ – USA
• Winston & Strawn LLP – https://www.winston.com/ – USA (Chicago, IL)
• Fenwick & West LLP – https://www.fenwick.com/ – USA (Menlo Park, CA)
• DLA Piper – https://www.dlapiper.com/ – Global (Headquartered in London, UK)

Crypto Tax Tools

• CoinLedger – https://coinledger.io/ – St. Louis, MO, USA
• Koinly – https://koinly.io/ – (Global, supports 50+ countries)
• CoinTracker – https://www.cointracker.io/ – USA

International Tax Advisors or Firms (outside the US)

• Danix Consultancy – https://danixco.com/ – Dubai, UAE
• Swiss CryptoTax GmbH – https://www.cryptotax.ch/ – Switzerland
• Bucher Tax AG – https://en.bucher-tax.ch/ – Lucerne, Switzerland
• Crypto & Taxes Portugal – https://www.cryptotaxesportugal.com/ – Portugal

Conclusion

At the end, it is worth mentioning again that there is no illegal tax dodge here. It is just a clever use of current rules. We’ve seen that by changing the timing of your sales, classifying crypto correctly, and even shifting jurisdictions, investors can lawfully reduce their tax bills.

For example, selling then rebuying crypto takes advantage of the missing wash-sale rule. Investing through an IRA or donating crypto can defer or eliminate capital gains. Forming the right entity or moving to a low-tax locale can save on massive US taxes.

Lastly, for smart tax planning, you will need better investment tracking and documentation. So, the next time you make a financial decision, keep taxes in mind.