How to make your crypto portfolio more tax-friendly

Tax season is upon us. While this time of year can be stressful, it tends to be especially difficult for those who have invested in cryptocurrency.

The reason crypto tax reporting in the US is challenging has to do with the fact that the Internal Revenue Service (IRS) and the US government consider cryptocurrency property, not currency, meaning it is subject to capital gains tax just like stocks or real estate.

This differs significantly from other countries, which have friendlier crypto tax laws. For example, in places like Portugal and Germany, cryptocurrencies are not subject to capital gains tax if they are held for more than a year.

While residents of other countries may enjoy more lucrative returns and more favorable tax laws, here in the United States, Uncle Sam wants a cut. And that cut can be hefty, depending on how long you’ve held onto your cryptocurrency. To avoid giving Uncle Sam too much of your profits, there is one simple but crucial thing you must do: Hold your cryptocurrency for more than a year.

Unlike other countries where this may mean no tax at all, by holding for more than a year, cryptocurrency investors can avoid the short-term capital gains tax. Compared to the long-term capital gains tax, which tops out at 20% and applies to crypto profits held longer than a year, short-term interest can be as high as 37%, depending on the investor’s income level.

Develop a tax-friendly investment strategy

In addition to avoiding short-term capital gains taxes, holding cryptocurrency investments for the long term can also help individuals reduce the risk associated with investing in a highly volatile asset class. In an ideal world, your goal should be to hold investments for at least five years.

This level of commitment requires investors to prioritize investing in cryptocurrencies that have a proven track record and provide real long-term value. Unfortunately, the majority of cryptocurrencies out there today probably do not meet these criteria. Although a hot topic and at times highly contentious debate, the only ones likely to meet this standard today in my view are Bitcoin (BTC 5.25%) and Ethereum (ETH 4.18%).

By holding investments like Bitcoin and Ethereum for the long term, individuals can reduce their exposure to riskier digital assets and potentially benefit from long-term price growth. Furthermore, by taking this approach, investors can avoid short-term capital gains tax, significantly reducing their tax liability and thus potentially increasing their overall return.

A bit of wishful thinking

The ultimate hope is that the US keeps pace with other countries when it comes to their view of crypto as currency and not property. Fortunately, as the debate over regulation heats up, demands for fairer tax laws arise.

For example, the proposed Cryptocurrency Tax Fairness Act would create a de minimis exemption for cryptocurrency transactions under $50, which would effectively eliminate taxes for smaller transactions.

In addition, the Infrastructure Investment and Jobs Act, which was enacted in 2021, includes provisions requiring cryptocurrency brokers to report certain transactions to the IRS. This was a crucial step in making it easier for individuals to accurately report cryptocurrency transactions on their tax returns and could help reduce the risk of non-compliance.

Inevitably, as cryptocurrencies become more mainstream, regulators will likely take a closer look at how they classify them and the tax implications of these investments. This could lead to clearer guidance on how cryptocurrencies should be taxed and could even spur further adoption.

But for now, crypto in the US is still seen as property. As such, this means crypto investors need to plan accordingly and take into account how this will affect potential returns. To make sure you maximize your profits and minimize your risk, make sure you only invest in high-quality cryptocurrencies that you plan to hold for a long time.