Bitcoin, the world’s most well-known cryptocurrency, was invented in 2008 as a form of decentralized digital currency that has soared in value since individuals first started buying and trading it. While its overall volatility tends to limit its use as payment for transactions, many investors have begun incorporating cryptocurrency into their portfolios to take advantage of its potential for substantial gains. (Most recently, Bitcoin reached a peak of over $100,000 in early December 2024.) However, selling Bitcoin (or other cryptocurrencies) to capture those gains risks triggering a significant capital gains tax bill. Rather than paying unnecessary, avoidable taxes on these transactions, it is possible to take advantage of tax-efficient strategies to save money and increase your return.
Understanding Capital Gains Tax on Bitcoin
In the U.S., the Internal Revenue Service classifies digital assets, including cryptocurrency such as Bitcoin, as property rather than currency. When cryptocurrency is sold, you must recognize any capital gain or loss on the sale and pay any applicable capital gains tax, just as you would if you sold a piece of real estate or a stock. If the cryptocurrency is held for under a year, any increase in value would be taxed as a short-term capital gain, which is treated the same as ordinary income (subject to a tax rate of up to 37%, depending on your marginal income tax bracket). Gains on Bitcoin held over a year would be taxed at long-term capital gains rates (0%, 10%, or 20%, depending on your income).
Say, for example, you bought Bitcoin at $45,000 but sold it at $100,000. The $55,000 you made from that transaction would be taxable not only at the federal level but also most likely in the state of your residency as well. California taxes capital gains as ordinary income, as do a majority of states, possibly taking as much as another 13.3% bite out of your profits depending on your income. If you own millions of dollars in Bitcoin, the potential tax consequence of an unconsidered straight sale can be massive.
Strategies to Avoid or Minimize Capital Gains Tax on Bitcoin Gains
Many people believe there is no choice but to pay whatever capital gains tax is owed when an asset is sold, but in fact there are many tax-saving strategies that can be employed to minimize or eliminate capital gains. One of the easiest is to hold Bitcoin for over a year to avoid higher short-term capital gains tax rates. Bitcoin can also be held in certain tax-advantaged accounts such as self-directed individual retirement accounts (IRAs), though investors should take care to ensure that the limitations of such accounts are in line with their investment goals. It is also possible to offset Bitcoin gains with losses by selling losing investments in the same tax year and thus minimize your tax burden.
In the case of Bitcoin investments that are large and have considerable appreciation, and which could potentially trigger gift or estate tax consequences as well, owners may be better served by more creative strategies that can also encompass charitable aims. One such method is a Charitable Remainder Annuity Trust (CRAT).
Tax Advantages of a Charitable Remainder Annuity Trust
In a CRAT, the donor contributes assets to an irrevocable trust that in addition to benefiting one or more charities (public charities or private foundations) also pays a fixed annuity to one or more noncharitable beneficiaries, calculated as a fixed percentage of the initial value of the trust’s assets. Assets belong to the trust, not the donor, and the trust lasts either until the donor dies or the chosen set period of no more than 20 years ends. At that point, any remaining funds in the trust are donated to the previously designated charitable beneficiaries.
The donor gets an up-front tax deduction for assets donated to the trust, and once they are donated to the trust they can be sold without triggering a taxable event. This ensures that a chunk of the value of a highly appreciated asset such as a Bitcoin investment is not lost to capital gains taxes, increasing the income potential for the annuity. The proceeds can then be reinvested into assets that are better geared for generating a consistent stream of income. While annuity payments to the noncharitable beneficiaries are taxed as ordinary income for them, the tax benefits to the donor, as well as the opportunity to capture the full market value of the underlying assets for both charitable and gifting purposes, make it a strategy worth considering.
The Importance of Consulting a Tax Advisor
The right tax-efficient approach will, of course, vary by investor and their individual tax, estate, and charitable goals. Whatever those happen to be, it’s essential they consult with a knowledgeable tax advisor before they sell or transfer their Bitcoin or other property. Working with an advisor experienced in cryptocurrency can help you not only avoid unnecessarily high taxes but also stay in compliance with all applicable tax laws so you can avoid possible audits or penalties in the future.
U.S. and International Tax Advisory Experts
At Bridge Law LLP, our tax advisory team is focused on protecting your wealth through solutions that reduce or eliminate your tax liability. If you’ve been dreading selling your Bitcoin because you believed that there was no way around paying a huge capital gains tax bill, we have solutions that can help you maximize your cryptocurrency profits as part of your comprehensive wealth preservation, tax minimization, and estate planning strategy. To learn more, schedule a consultation by contacting us here.