5 Easy Ways To Reduce Your Crypto Taxes
It’s no secret that the ATO wants a piece of your crypto gains, but are they taking more than you think they should? Thinking ahead about how you want to structure your portfolio can reduce your crypto tax significantly down the road. Use the right tools and methods and you can save thousands in tax. Here are 5 easy methods to help reduce your tax obligations without doing anything risky.
The first strategy is an obvious one, if you hold an asset for longer than 12 months the amount of capital gains tax owed on the transaction could be reduced by 50%. Holding long term is one of the easiest ways to reduce your tax and can also help reduce the volatility of your trades if you aren’t trying to time the market.
A capital gains tax event only occurs when you dispose of the asset so as long as you continue to hold you won’t owe any tax. However, there is one important caveat to this strategy. Disposing of an asset doesn’t just occur when you sell a token, if you transfer your crypto somewhere that results in you not having ownership or control of the asset you have in the eyes of the ATO disposed of the asset.
This is quite technical but what it means for crypto users is simple. Using some projects or dApps actually take control of your funds when you deposit, meaning this transaction would count as disposal. Not only would you have to pay taxes on this move but it would also reset the period you have held the asset back to 0.
DeFi protocols like Compound use their own tokens to run the platform, when you deposit funds they transfer your tokens automatically into cToken equivalents e.g. if you deposit ETH they trade that for cETH. As this is a token to token transaction it is also a capital gains tax event.
If you are planning on using this strategy it is important to be careful when moving your crypto around or using DeFi projects to earn passive income. Make sure the transaction doesn’t trigger a capital gains event.
Self-managed super funds are now allowed to invest in crypto assets, if you are a big believer in the long term potential of certain cryptocurrencies like Bitcoin or Ethereum it could be worth using a SMSF to hold these assets. Using a super fund has certain tax advantages and with new laws, you can hold some crypto as a long term investment in your super.
There are two potential issues with this strategy. First, you must have a SMSF to hold your own crypto assets, setting one of these up can be a tedious process so it is only worth it if you already have it set up. Second, this strategy only works for long term investments. Super is a means to save for retirement and not for short term gains, as such the government doesn’t like you trying to trade your retirement funds away.
This strategy is slightly more complicated and only important if you want to get involved in DeFi. One of the key aspects of DeFi is the ability to lend your cryptocurrency out to others and earn a generous interest rate in return. As it would in a typical bank account interest income is generally classified as income and subject to income tax and not capital gains.
This is how the typical DeFi lending process would work:
You deposit funds into your DeFi platform of choice.
Periodically interest in the form of the token you deposited is airdropped to your account.
You withdraw your funds back into your main wallet.
In this case, when the interest is periodically airdropped to your account an income tax event occurs and you owe tax based on the amount airdropped.
How cTokens change this?
Compound is a DeFi lending platform that allows you to earn interest but the way they handle interest payments can give you a potential tax benefit.
Here’s how the process works with Compound:
You deposit your funds to Compound, which are automatically transferred to the equivalent cTokens, for example you deposit Dai and it is converted to cDai.
Over time as you earn interest you aren’t airdropped tokens, instead to value of your cDai increases to what it would be as your deposit + interest.
Only when you withdraw your funds and it is changed back from cTokens to the original token (deposit + interest earned) does it trigger a tax event and not an income tax but a capital gains tax instead.
In this case, you earn interest as a capital gain and not income and more importantly you get to decide when to incur the tax event rather than when the platform airdrops you tokens.
Another advanced strategy using DeFi can help if you are holding long term. Let’s say you want to hold a portfolio of 50% BTC and 50% ETH, over time the value of ETH increases relative to BTC, and your portfolio is now 40% BTC and 60% ETH. If you wanted to hold your original portfolio long term you would have to sell some ETH and buy BTC to get back to the original balance. This would trigger a capital gains event when you sell the ETH, every time you do it it will incur another tax.
What if you use TokenSets instead?
TokenSet is a new project in the DeFi space that tokenizes a portfolio. In our above example, you would buy a Set representing a portfolio of 50% ETH and 50% BTC. The same event occurs and the Set now represents a portfolio of 60% ETH and 40% BTC, however the portfolio rebalances itself. As the amount of Set tokens you hold never changes and you never have to exchange them you don’t incur any taxes until you sell the Set itself.
As described above holding an asset for longer than 12 months reduces the capital gains tax owed by 50%. What if you run into a scenario where you need some of your portfolio gains but don’t want to sell and owe tax?
One option would be to borrow against the crypto as collateral, this way you can access funds from your portfolio without selling. You can hold 12 months and get a tax benefit when you do decide to sell while getting access to Australian dollars in the short term.
Of course, the downside is that you have to pay interest on the loan, but if it means reducing your capital gains by 50% and giving you access to funds immediately it could be worth it.
As you can see there are quite a few simple and complex ways to help reduce your tax obligation depending on what you want to do in the crypto space. Whatever you’re doing Crypto Tax Calculator can help keep track of your tax obligations. Whether you are holding long term or using some more complex DeFi products CTC can help keep track of all of this for you.
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