Investors in Bitcoin (CRYPTO: BTC) have been rewarded with handsome gains that have made it tempting to cash in and take profits. But if you’re one of them, be careful: Your tax filing status and income could cause you to pay a pretty penny on your Bitcoin profits. For some investors, there’s a way to bypass or drastically reduce taxes if you check the box on the IRS rules that give you access to the best tax rates for Bitcoin investors.
Here’s information you should know to determine if you qualify for the 0% tax bracket — and the incredible tax recipe that could let you claim up to $80,800 in Bitcoin profits tax-free.
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What you should know about Bitcoin and taxes
Bitcoin is treated as property instead of currency for federal tax purposes. That means Bitcoin receives the same tax treatment as stocks and is taxed at capital gains tax rates. But not every action you take will lead to a tax bill.
First, buying Bitcoin is not a taxable event. You won’t have to write a check to the IRS if you purchase Bitcoin from a cryptocurrency exchange and hold it in your account.
Once you sell your Bitcoin for a profit, you trigger capital gains taxes. Let’s say you bought Bitcoin for $15,000 and sold it at $35,000; you’ve earned a $20,000 capital gain that you may have to split with the IRS.
There are two categories of capital gains taxes: short term and long term. If you hold your Bitcoin for a year or less, you’ll pay short-term capital gains rates that are taxed like ordinary income. Those rates could climb as high as 37%. But if you’re looking for a deal on your tax bill, it’s best to hold your Bitcoin for over a year.
Gain access to tax-free profits
The IRS rewards investors who hold their Bitcoin for over a year with special tax rates. You’ll gain access to the long-term capital gains tax rates of 0%, 15%, and 20%, depending on your income and filing status. This is where you can capitalize on tax-free profits from your Bitcoin investment.
Let’s say you are married and file a joint return with a combined taxable income of $60,000 in wages and $20,000 in long-term capital gains from Bitcoin. You would be eligible to pay zero taxes on your Bitcoin profits. For 2021, married couples with taxable income up to $80,800 qualify for the 0% long-term capital gains rates. This example works because the $60,000 in other income and $20,000 in Bitcoin gains adds up to less than the $80,800 limit.
Once you’ve exceeded the income threshold for your filing status, you’d automatically get kicked up into the 15% tax bracket. So in the above example, if you had $25,000 in long-term gains from Bitcoin sales, the first $20,800 would get the 0% rate, but the remaining $4,200 would get taxed at a higher rate.
Since the goal for most people is to make their income as high as possible, you’re unlikely to get tax-free treatment on the full $80,800. However, in a year of unemployment, retirement, or any other situation where you experience lower taxable income, you could see greater benefits from the 0% rate on long-term capital gains.
The table below provides more details on ways you can unlock the possibilities of a lower tax bill.
2021 long-term capital gains tax rate
|
For Single Filers With Taxable Income of… |
For Married Joint Filers With Taxable Income of… |
For Married Couples Filing Separately With Taxable Income of… |
For Heads of Households With Taxable Income of… |
…This Is the 2021 Long Term Capital Gains Tax Rate |
|---|---|---|---|---|
|
$0 to $40,400 |
$0 to $80,800 |
$0 to $40,400 |
$0 to $54,100 |
0% |
|
$40,401 to $445,850 |
$80,801 to $501,600 |
$40,401 to $250,800 |
$54,101 to $473,750 |
15% |
|
Over $445,850 |
Over $501,600 |
Over $250,800 |
Over $473,750 |
20% |
Data source: IRS.
Choose the best investments for your portfolio
As enticing as tax-free profits sound, that doesn’t mean you should pour all your money into Bitcoin to avoid tax liability if you’re in a lower tax bracket.
Buying and holding Bitcoin is only one way to gain access to long-term capital gains rates. Investing in stocks is another way. By keeping stocks over a year or earning more qualified dividends, you can also enjoy thousands of dollars of tax-free income. Because the stock market has been around longer than the cryptocurrency market, it’s considered a safer way to get your feet wet as an investor.
So choose the investments that work best for you and let the tax code work in your favor. Bitcoin is insanely volatile but if you’ve already invested in it, you have a chance to keep more of your profits by following a few simple steps.
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Charlene Rhinehart, CPA owns shares of Bitcoin. The Motley Fool owns shares of and recommends Bitcoin. The Motley Fool has a disclosure policy.