Alternatives to tax-loss harvesting
Here's part one in a two-part series to help you with tax planning
Hey all - goood morning! Hope all of you are doing well these days. As part of a collaboration with 3CryptoCpas, we’ve put together a two-part piece on alternatives to tax-loss harvesting.
For those of you with lots of unrealized gains and no more tax-loss harvestable opportunities, here are a few strategies you can employ to optimize your tax liability!
1. Donate crypto that currently has large unrealized gains
You can donate some portion of your current crypto holdings that have increased in value to a qualified charity. A key qualification here is that you are expected to donate the crypto-assets directly to the charity, rather than liquidating and donating the cash.
By donating you would avoid capital gains completely while generating a material tax deduction. How? Well, your deduction will be calculated based on the fair market value of your crypto assets at the time of donation.
There are two additional requirements:
If the fair market value of your crypto donation is over $250, you will have to get a written acknowledgment from the charity. This is a required piece of evidence in the case of an IRS audit.
If the fair market value of the asset is above $5k, you will need to get the asset professionally appraised. You will also have to fill out Form 8283 when filing your taxes.
There is another option available for high-net-worth individuals. Create a donor- advised fund, a charitable remainder trust, or a private foundation that would make it transactionally easier to donate large sums. Consult with your CPA for guidance on this.
2. Qualified Opportunity Zones
Qualified Opportunity Zones (QOZs) were written into law as part of The Tax Cuts and Jobs Act. This initiative sponsored and pushed forward by the Trump administration is meant to incentivize financing for underdeveloped areas around the United States.
Areas that have been declared as QOZs offer incredibly attractive tax benefits. You can invest in a QOZ fund with proceeds from a crypto sale within the past 180 days. If you hold your investment for 10 years, you will not be required to pay any taxes on the gain you recognized when selling the asset or any profits recognized over the life of the fund. Wow!
Consult your CPA or wealth manager for additional guidance for contributing to QOZs.
3. Passing down a stepped-up cost basis to your heirs
This is a little dark, but it is worth mentioning.
If you pass away while holding tokens that have appreciated, then whoever inherits those tokens will recognize a new basis at the fair market value of the tokens at the time of your death. This means that it is incredibly important for token holders to make plans for the transfer of crypto assets in the case of an unexpected death. This could be a set of instructions in a safe or even a digital lockbox.
Let’s break down the calculation a little further.
Let’s say you bought Token X for $5, making that your cost basis, and it increased in value to $100. If you were to sell it, you would have to recognize a $95 gain. However, if you were to pass away and Token X is inherited by your estate, the estate will recognize their basis in the Token at $100, the fair market value at the time of death.
This piece is the first of two parts that will cover approaches to minimizing taxes on realized and unrealized capital gains. Part two will cover more aggressive approaches that are not recommended for everybody.
None of the aforementioned content should be treated as financial or tax advice. Please consult with a professional to determine what would work best for your circumstances.
As a disclaimer, please note that the IRS still hasn’t issued crystal clear guidance when it comes to crypto, specifically DeFi and NFTs. Guidance to some of the questions will come from case law and rules for similar assets/investments. Please speak with your tax professional before engaging in any transaction as this is not formal tax advice.
Special thanks to @fintaxdude and @EmDeeEm for helping put this together!