You made it! Another tax year in the bag — or at least deferred until October. Now you can take the time to think about strategy.
Tax strategy and tax liability are two sides of the same coin. An effective tax strategy can mitigate one’s tax liability. With cryptocurrencies, the difficulty lies in understanding the true cost basis of the assets as they move around. NODE40 identifies and tracks the basis of specific tax lots, allowing the application of a strategy that can be defended with an audit against the blockchain.
Knowing one’s exact basis allows for proactive management of not only crypto assets but also enables tax strategies such as tax loss harvesting across asset classes.
To illustrate, assume tax payer Mary sold an NFT for $100,000 that she had purchased for $100. Further assume that she intends to sell some bitcoin to reduce her $99,900 gain; a simple tax loss harvesting strategy.
To offset the gain, she must know the basis for each bitcoin lot.
From the table above, Mary can eliminate her gain entirely by selling some or all of the lot she received on 11/13/2021; lot 4.
By selling (or gifting, trading, donating etc.) 3.85417 BTC from lot 4, she would realize a loss of exactly $99,900.
In this example, Mary would part with 3.85 BTC. Alternatively, she could have opted to sell lots 3, 5, and 7 but would have only realized a loss of $47,776 (and still pay tax on a $52,214 gain) and would have lost 5 BTC.
By visualizing tax lots and their basis, Mary is able to part with the least amount of bitcoin and wipe away her entire loss.
The ability to identify specific lots is useful for both strategy and execution but each lot’s basis must be known and the tax payer’s intent must match the execution. Proper execution will irrefutably support the strategy.
The ability to define how transactions should be executed is a powerful tool for financial professionals. Conversely, applying an accounting methodology such as FIFO or HIFO that does not reflect actual execution is an unnecessary risk and may even violate corporate controls..
To produce a defensible audit trail, selecting lots for a tax strategy must take place prior to transaction execution. Tax lots cannot be selected ex post facto. Lot selection should support one’s tax strategy, thus enabling an accurate audit trail.
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Contact us to learn how financial advisors are using crypto tax startegy to help their clients.