As we’ve noted before, each time you trade one crypto token for another a capital gain or loss is created. And you need to report that income on your tax return – regardless of whether or not you convert it back into a fiat currency.
Capital Gains Holding Period Resets
Savvy blockchain investors are aware of this and plan accordingly. But one of the things that will often slip by their planning – and even the planning of their less-than-familiar-with-crypto CPA – is that the holding period also resets with each of these transactions.
Gains on assets that have been held for more than one year are considered long-term capital gains. Long-term capital gains receive a significantly lower tax rate compared to short-term capital gains, which are taxed at ordinary income rates. Long-term capital gains are taxed at a maximum of 20%, which is much lower than the current top tax rate of 37%.
But because many crypto investors so actively trade between different coins, a lot of them do not hold any individual token for more than a year even if they never cash out and convert back into a fiat currency.
And depending on the investor, that may still make the most sense. The superior gains they are getting from the market is offsetting the additional tax they are paying.
Strategies to Qualify for Long-Term Capital Gains
But even for active traders, there are strategies that could and should be considered.
For instance, let’s say your portfolio mostly consists of different Top 100 projects. The market largely follows the price of Bitcoin (with some variation, of course). Some will perform better than others, but they typically follow the same general trendline.
Given this, you may want to choose a specific token to do your day trading with. If you use all of them to actively trade with, it is much less likely that any of them will be held longer than a year.
Just to illustrate, let’s say most of your holdings are some of the Top 10 projects – BTC, ETH, ADA, BNB, SOL. But you designate 10% of your portfolio for altcoins and day trading.
If you are using all five of those projects to fund your altcoin trading, you may keep resetting your holding period on them. You trade your BNB for an altcoin, the altcoin surges, and a month later you trade it back for BNB. Then you do the same thing with your ETH the next month.
Each time you’re doing this, you’re resetting the holding period on your tokens and making it harder to get any age on them to qualify for long-term capital gains.
At least from a tax perspective (we do not give investment or trading advice), you are much better off designating a specific token to trade with and leaving the other four projects in your portfolio so they can qualify for long-term capital gains.
There may of course be market considerations that override these tax benefits. But from a pure tax standpoint, this approach is often a no brainer.
Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
