6 easy ways you can invest in crypto (including tax-friendly options)

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You’ve probably noticed that the use of various cryptocurrencies is exploding! It seems like new coins and blockchain technologies are getting created every day. So, if you’re eager to learn more and invest in crypto but aren’t sure where to start, keep reading.

 

This post will review what cryptocurrency is, various ways to buy it, tax rules for crypto profits and a strategy to start stacking coins. You’ll learn six ways to invest in crypto, including some clever, tax-advantaged options for avoiding capital gains taxes altogether.

What is cryptocurrency?

Cryptocurrency, or crypto, is digital money, known as tokens or coins, that you can use to buy goods and services or hold as an investment. Bitcoin is one of the most well-known cryptos, with a total value of about $1.1 trillion in December 2021. Still, there are thousands of alternative or altcoins, such as Ethereum, Solana, and Polkadot. The total value of all cryptocurrencies is about $2.6 trillion.

 

To understand how cryptocurrencies work, you need to know something about their underlying technology, which is a blockchain. There are different blockchains in use today, but their purpose is to verify transactions and store data in a secure, open ledger that anyone can see.

 

Blockchains are decentralized databases spread across many computers all over the globe. No one person or organization owns or manages public blockchains, making them difficult for hackers to manipulate.

 

Blockchain technology was developed for Bitcoin; however, other crypto networks, such as Ethereum, are also powered by blockchains. Also, there are many other uses for blockchain technology besides cryptocurrencies. They include smart contracts that automate the terms of agreements, recordkeeping for assets like real estate and supply chain management.

 

To sum up, a blockchain is a distributed database with many uses, including powering cryptocurrencies.

Why do people use cryptocurrency?

If you wonder why people are investing so much money into crypto right now, there are various reasons. Many crypto supporters, including me, believe digital currency is the future of money.

 

While blockchain transactions are fully transparent, crypto is anonymous. That means you can buy, sell and exchange it without revealing your personal information or identity. Crypto transactions are peer-to-peer, removing banks as middlemen who control the money supply.

 

Many people buy crypto because they think it will increase in value despite its volatility. Bitcoin was trading around $20,000 in December 2017, hit an all-time high of $69,000 in October 2021, and is now bouncing around $48,000.

 

If the crypto roller coaster ride scares you, there’s a special crypto class called stablecoins pegged to specific assets, such as the U.S. dollar. That gives you a way to own digital currency without any price volatility.

 

Bitcoin is a unique cryptocurrency because it’s hard-coded never to have more than 21 million coins created. And more than 18 million have been mined to date. Many people buy and hold Bitcoin because they believe its limited supply will cause the price to rise over time. This strategy is known as HODLing, which stands for “hold on for dear life.”

How do you buy cryptocurrency?

To buy cryptocurrency, you must have a wallet, which can be an online app or offline hardware device, to store it. If you use an exchange, such as  BlockFi, Crypto, Gemini or Coinbase, it’s as easy as opening an account, transferring your dollars, and making crypto purchases. They act as an investing platform and a “hot” online wallet. However, you can move your crypto into a “cold” offline wallet at any time for added security.

How is cryptocurrency taxed?

Crypto is taxed just like any other asset, such as stocks and mutual funds, where you must pay capital gains tax when you realize a gain. For example, if you buy $100 of crypto and sell it for $150, you must pay tax on your $50 profit.

 

Also, when you buy something with crypto or trade crypto that’s increased in value, it’s a taxable event. Let’s say you bought a bitcoin for $20,000 that’s now worth $50,000, and you use it to buy a car. You’d have a $30,000 capital gain to report.

 

Other taxable events include:

  • Receiving crypto as payment for a service or mining it.
  • Lending crypto and receiving interest payments.
  • Staking crypto and earning interest or rewards.

So buying and holding crypto isn’t a taxable event. You only owe tax when you sell, spend or trade crypto that’s risen in value, or you get paid interest on crypto you own. If you sell crypto for a loss, it can offset your gains, up to annual limits, just like other assets.

What are cryptocurrency capital gains taxes?

Capital gains tax rates depend on your tax filing status, income, and length of time you own an asset. If you own a coin (or other assets) for fewer than 365 days and sell it for a profit, you owe short-term capital gains tax, which equals ordinary income taxes. Today’s tax brackets range from 10% to 37%, depending on how much you earn.

 

However, if you own a coin for longer than a year, you owe long-term capital gains tax, which ranges from zero to 20%, depending on your income. So, holding assets for longer than a year is a wise strategy for cutting taxes, especially if you’re a high earner.

 

Another smart way to avoid capital gains tax on crypto is owning it inside a tax-advantaged account, which we’ll cover in a moment.

 

IMPORTANT! Crypto exchanges must file form Form 1099-K for clients with more than 200 transactions and more than $20,000 in trading during the year. And you must report crypto gains and losses on Form 8949.

Taxable options to invest in cryptocurrency

Here are three popular ways to buy cryptocurrency that will trigger capital gains tax when you sell, use, or exchange it.

1. Crypto exchanges

As I mentioned, buying crypto through an exchange is an easy and popular way to buy and sell it. Just open your account and fund it, and you can buy just about any coins you like and keep them in a handy digital wallet.

2. Crypto savings accounts

Many crypto exchanges allow you to earn interest on specific coins. Like bank savings, you make a deposit, the institution lends it out, and pays you interest. You can receive earnings in crypto of your choice and at significantly higher rates than a regular bank.

Right now, you can earn these impressive interest rates on your crypto savings, depending on your balance and the duration you lock it up without being able to make a withdrawal, such as for one or three months.

  • BlockFi pays up to 9% APY on USD Coin (USDC), Gemini dollar (GUSD), Paxos (PAX), Dai (DAI), 5% on Ethereum (ETH), and 4.5% on Bitcoin (BTC).
  • Gemini pays approximately 8% on Gemini dollar (GUSD), TerraUSD (UST), and USD Coin (USDC), 1.76% on Ethereum (ETH), and 1.49% on Bitcoin (BTC).
  • Coinbase pays up to 5% on Cosmos (ATOM).
  • Crypto pays up to 10% on USD Coin (USDC), 5.5% on Ethereum (ETH), and 4.5% on Bitcoin (BTC).

IMPORTANT! Unlike a regular bank, your money in crypto exchanges and savings isn’t FDIC insured up to certain limits. You could lose your crypto deposit if the institution fails. However, some crypto platforms offer insurance against losses, so be sure to read the fine print.

3. Crypto-rewards credit cards

If you’re not sure you want to buy crypto or stablecoins, there’s another way to earn crypto without risking your own money: using a crypto rewards credit card. You earn crypto on your spending or points to convert to cryptocurrency.

 

The BlockFi Rewards Visa Signature Credit Card has no annual fee and earns 3.5% back in Bitcoin during the first three months and an unlimited 1.5% back after that. Your rate bumps to 2% if you hit $50,000 in annual spending.

 

If you want to earn other cryptocurrencies, the Venmo Credit Card pays cashback you can redeem for Bitcoin, Ethereum, Litecoin or Bitcoin Cash. You can earn 3% on a top spending category of your choice, 2% on a second category and 1% on all other purchases.

Tax-friendly options to invest in cryptocurrency

Here are three clever ways to buy cryptocurrency that don’t trigger capital gains.

1. Crypto Individual Retirement Accounts (IRAs)

Most investment platforms, such as Vanguard and TD Ameritrade, don’t support crypto trading, so you need a self-directed IRA that offers it. Using a crypto IRA is a smart way to buy and sell crypto because you never have to pay capital gains tax!

With a traditional IRA, your contributions are tax-deductible, and you pay ordinary income tax on amounts withdrawn in retirement. Contributions are taxable with a Roth IRA, but withdrawals (including all investment growth) are entirely tax-free in retirement.

 

Bitcoin IRA is the oldest and largest cryptocurrency IRA company. It allows you to earn up to 6% APY, invest in Bitcoin, many altcoins, and even physical gold. So, if you want to diversify your IRA with precious metals, it’s a great option. Another company, BitIRA, says it’s the most secure crypto IRA with a fully-insured cold wallet storage solution.

 

For 2021 and 2022, the annual contribution limit for a regular or crypto IRA is $6,000 or $7,000 if you’re over age 50. Anyone with at least that much-earned income is eligible for a traditional IRA; however, there are annual income limits to qualify for a Roth IRA.

 

READ MORE: Should I get a traditional or Roth IRA?

2. Crypto Coverdell Education Savings Accounts (ESAs)

Coverdell ESA is a great way to save for a child’s education, from kindergarten through graduate school. And yes, you can open a self-directed ESA and invest in crypto. Check out Directed IRA, where you can buy over 20 cryptocurrencies, including Bitcoin, Ethereum and Litecoin.

 

Contributions to a Coverdell get taxed, but withdrawals are tax-free if you use them for qualified education expenses, such as tuition, books, equipment, and supplies. There’s an annual income limit to qualify for Coverdell contributions, and you can save up to $2,000 per student per year.

3. Crypto Health Savings Accounts (HSAs)

Using a health savings account to save for current and future healthcare expenses is one of the best financial moves you can make. They give you the following three tax benefits:

  1. Tax-deductible contributions.
  2. Tax-free investment growth.
  3. Tax-free withdrawals (if you spend them on qualified healthcare expenses).

While you typically can’t invest your HSA balance in crypto, self-directed accounts allow it, such as Directed IRA. Note that to qualify for an HSA, there’s no annual income limit, but you must be enrolled in a high deductible health plan.

 

For 2021, you can contribute up to $3,600 or $7,200 if you have a family health plan. The limit increases slightly for 2022 to $3,650 or $7,300. And if you’re over age 55, you can contribute an additional $1,000 per year.

 

READ MORE: Your guide to saving money with an HSA now and in retirement

Should you invest in cryptocurrency?

Whether you should invest in crypto depends on various factors, including your risk tolerance, comfort with or knowledge of the technology and retirement time horizon. Remember that all crypto is highly speculative and volatile.

 

My best advice is to maintain a diversified portfolio that insulates you from market downturns. If you want to own crypto or any alternative investment, make it a small percentage of your overall portfolio, such as no more than 5%. Limiting your exposure allows you to profit from the upside without risking too much of your financial security.

 

What questions do you have about cryptocurrency? Leave me a voicemail at 302-364-0308 or email me at money@quickanddirtytips.com.

 

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originally appeared on 
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How to pay taxes on cryptocurrency

 

Over the past decade, cryptocurrency has slowly but surely become one of the hottest investments on the market. While many people were initially skeptical of crypto’s staying power and appeal, the rise of cryptos like Bitcoin has caught the attention of an increasing number of investors. But the IRS is also homing in on crypto taxes—and it’s important that investors know the basics regarding how to file and how to pay taxes on cryptocurrency.

 

Unfortunately, the IRS doesn’t exactly make it easy to understand how to calculate crypto investors’ tax liability, so a lot of the responsibility to get it right lands on the individual investor.

 

Of the 6 things to know before investing in crypto, the fact that crypto is taxed is right up there on the list. Read on to learn all you need to know about crypto taxes, including how to file and pay taxes on cryptocurrency.

 

Related: Guide to taxes and cryptocurrency

 

 

Jirapong Manustrong / istockphoto

 

There are many rules and regulations governing crypto, but the most basic thing to understand is that crypto investors are required to report their holdings and gains to the IRS when they file their taxes.

 

The IRS views cryptocurrencies (which it refers to as “virtual currencies”) as property. Not currency. And because of that, Uncle Sam wants to know what you’re holding, and many crypto holders will have tax liabilities . PDF Fileassociated with their holdings.

 

As they would with any other property they might own, crypto holders who purchased crypto like a stock or other asset will need to keep track of their crypto transactions. They’ll also need to report the value of their holdings (in U.S. dollars) on their tax filings.

 

One caveat: cryptocurrency received as a gift or a transaction, or that is mined, is instead treated as income by the IRS, and taxed accordingly.

 

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In many ways, investing in cryptocurrencies like Bitcoin is similar to investing in other assets, like stocks or bonds. Likewise, taxes are determined in similar ways.

 

For instance, when an investor buys and later sells a stock, they have a tax liability on their realized gains. They made money, or income, from the sale, and now owe taxes against that income. It’s a similar situation when it comes to tax on cryptocurrency.

 

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Here are some situations in which crypto investors will generate a tax liability on their holdings:

  • Cryptocurrency is sold for cash: If you made a profit, that’s a capital gain. Depending on how long you held the crypto before selling, it would either be a short-term or long-term capital gain.
  • Cryptocurrency is used to purchase a good or service: Technically, here you are selling your crypto for dollars, then using the dollars to pay for a good or service. In the selling, capital gains taxes may apply.
  • Converting one cryptocurrency to another (exchanging cryptos): Converting or exchanging one crypto for another is selling the one to purchase the other. As a result, you may have to pay tax on the sale of the first crypto.
  • Being paid by an employer in cryptocurrency: Even if you get paid in crypto, it will get taxed as income.
  • Mining cryptocurrency: Proceeds from mining are typically taxed as income. It’s also possible for some miners to be taxed as a business.
  • Crypto is acquired via an “airdrop” or “hard fork”: In the event of a hard fork that results in new coins, those new coins are taxed as income.

Make no mistake about it, if a return is generated—positive or negative—or some type of income is realized from holdings, your crypto will need to be reported to the IRS. This is why it’s important to keep track of any and all crypto transactions.

 

Many crypto exchanges will keep track of an investor’s transaction history (like a brokerage would with stocks). But it’s not a bad idea to make individual notes, too. Or, if you’re not quite sure what to do, consult a professional.

 

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When it comes to filing and paying taxes on cryptocurrency, here are the steps that should be taken.

 

 

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Reference the list of above to check if any of your transactions may have generated a tax liability. If so, it’s likely you’ll have a return to report to the IRS.

 

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These will need to be reported on your tax return (your exchange can likely provide these in a document for you.) This is a paper trail for the IRS to follow.

 

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The IRS requires specific forms depending on the activity an individual has conducted with their crypto. That could include making calculations on Form 8949 and then reporting the results on Schedule D of Form 1040 , which outlines and summarizes capital gains or losses. Or, Form 1099-MISC , which is used to report income from rewards if the amount exceeds $600 for the year.

 

If you do owe taxes as a result of your crypto investing activity, you can pay the IRS directly. But since crypto taxes can be complicated, don’t be shy about reaching out to a professional for help.

 

 

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When it comes to lowering your crypto tax liability, many of the same strategies that are used against traditional investments, like stocks, apply to crypto holdings. Here are a few examples:

 

 

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The buy-and-hold strategy is simple: The longer an investor holds on to their crypto, the lower their potential tax bill when they do eventually exchange it for cash. If it was held for a year or longer, then long-term capital gains tax rates apply On the other hand, if the investor sells their crypto after holding it for less than a year, then short-term rates apply

 

 

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If a loss is realized on a crypto holding, it can be used to offset the gains made on other holdings. This is called “tax-loss harvesting,” and is a common tactic used to lower tax liabilities on other investments. Investors can use tax-loss harvesting to offset as much as $3,000 in non-investment income.

 

One thing to keep in mind, though, is that if crypto is somehow stolen or lost, investors are out of luck. They won’t be able to apply the loss against their gains to lower their liability.

 

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The IRS classifies crypto as property, and property donations are tax-deductible and not subject to capital gains taxes.

 

Here’s how this might work in an investor’s favor: If an investor bought a Bitcoin for $10,000 and it now has a value of $35,000, they would owe capital gains taxes on that $25,000 gain. By donating it, they can avoid those capital gains taxes and also take a deduction “generally equal to the fair market value of the virtual currency at the time of the donation if you have held the virtual currency for more than one year,” according to the IRS.

 

 

Andre Francois on Unsplash

 

Depending on the circumstances, crypto may be taxed as income, or as property.

 

Cryptocurrency taxes are very real, as are the consequences of ignoring tax liabilities. There are stiff penalties for people who are caught avoiding or otherwise failing to report investment income.

 

But by keeping track of your crypto holdings and transactions, managing your cryptocurrency tax liabilities shouldn’t be too difficult. As always, you can and should contact a professional if you feel like you’re in over your head.

 

Learn more:

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.

 

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