Bitcoin and its cohorts have had a mixed year. The adoption rate is up, as is the number of places and ways that consumers can use cryptocurrencies, but the price is down. This combination of circumstances creates a few interesting tax planning opportunities. With one quarter left in the tax year, it is not too late to take action to trim your tax bill.
Harvest Your Losses To Offset Your Gains
Most tax planning strategies involve timing actions that you would have taken anyway in order to exploit temporary advantages in your situation. For volatile assets such as bitcoin, the easiest thing that you can do this year is to harvest losses by selling while the market is down. This might be an especially good strategy if you have substantial gains from early in the year that you need to offset. Since IRS wash sale rules only apply to securities (and cryptocurrencies aren’t securities), feel free to re-purchase the coins you just liquidated if you intend to hold them long term.
Deduct Your Hardware Purchases
Computer equipment purchased in connection with a trade or business usually must be capitalized and depreciated over a five year period. For companies engaged in cryptocurrency related operations, this includes computers used as controllers, mining hardware, cooling fans and other gear used in support of a mining operation. This equipment tends to wear out or become obsolete long before the end of the recovery period, a major disadvantage from a tax standpoint. However, businesses can elect under Section 179 to expense up to $25k of the value of equipment purchased and put into service during 2014. Note that in order to qualify, equipment must actually be put into operation, not just on order or under contract.
Tax Extenders
Several popular deductions and credits oriented toward individuals and small businesses (known collectively as “tax extenders”) expired at the end of 2013. Prior to 2014, Section 179 Expense treatment was capped at $500k and was complemented by Bonus Depreciation rules. Since Section 179 expense treatment is limited by income (it can’t produce a loss), Bonus treatment would have allowed a taxpayer to elect 50% depreciation in the first year and take the rest throughout the asset’s useful life.
Another tax extender that expired at the end of 2013 was the deduction for state and local sales tax. Most purchases of equipment are subject to sales tax, so this is yet another way to save money by accelerating a large purchase that you may have already intended to make- if this deduction returns.
The catch is that any extension approved by Congress may not occur prior to the end of the tax year (though it would likely be retroactive). Though the political will to extend them seems to be present in Congress, neither the House nor the Senate has yet taken action to do so.
Write Off Your Theft Losses
If you lost bitcoins at Mt. Gox or another exchange, ordered something from Butterfly Labs or another manufacturer that you didn’t get (and didn’t receive a refund for), or invested in a cryptocurrency start-up that went bust, then you may have a deductible loss. IRS theft and business loss rules are complex, so consult your tax adviser if you think you might qualify.
Donate Something
Philanthropy is an integral part of the long term tax and estate plans for many taxpayers. You may consider donating some of your hoard of bitcoins before the end of the year in order to take the charitable contributions deduction. You can convert bitcoins to dollars and deduct the cash, but many charities now accept donations directly in bitcoin. In this case, your deduction will be based on the dollar price of bitcoin on the day you make the donation. Be sure to obtain a receipt!
Fund Your Retirement
If you qualify to contribute to an IRA this year and you haven’t fully funded one yet, you might want to cash out some of your bitcoins to save for retirement. You can deduct up to $5,500 from your taxable income ($6,500 if you are age 50 or older) by contributing to an IRA. There are plans in the works for one or more bitcoin backed mutual funds, so if you want to keep your cash invested in bitcoin then be sure to check whether your broker is likely to offer them.
Though there are a few things in which IRA accounts are prohibited from investing, cryptocurrency doesn’t appear to be one of them. If trading is your favorite past time and you want to do so free of tax, you might consider opening a Self Directed IRA (these are often called “checkbook IRAs”). A self-directed IRA allows you to directly manage your retirement assets, investing in (almost) anything you want.
If you participate in an employer run 401(k) or 403(b) plan and haven’t contributed the maximum for 2014, you could ramp up your contributions for your last few paychecks of the year, replacing the “lost” income with liquidated bitcoins. This would have the effect of “deferring” some of your bitcoin gains into your retirement account.
If you are really ambitious, then you may qualify to establish a SIMPLE IRA or SEP for your bitcoin business so that you can put even more away.
Net Investment Income Tax
The dreaded Net Investment Income Tax deserves a mention in this article. This isn’t a tax planning strategy, but may be a good reason to do what you can to reduce your taxable income. This 3.8% tax became law in 2010 as part of the Affordable Care Act, went into effect on January 1, 2013 and applies to most of your net investment and passive activity income if your modified adjusted gross income exceeds $200,000 (or $250,000 for married couples filing jointly). Capital gains on cryptocurrency trading are subject to the Net Investment Income Tax.
These are just a few of the possible strategies that may help to reduce your 2014 tax bill. If you have suggestions for others, please share them in the comments. Always consult a qualified tax accountant before executing any tax avoidance strategy.
UPDATE 10/29/14- Here is a longer, more generic list of tax tips that I sent out to my own clients.