If you’ve been following the latest financial news, you’ve probably seen the price of Bitcoin skyrocketing.
It went from about $40,000 a coin to over $100,000 in the past year. Whether you’re an experienced trader or just getting started, it’s critical to understand various ways to invest in crypto, including tax-advantaged options.
What is cryptocurrency?
Cryptocurrency or ‘crypto’ is digital money that you can use to make purchases or hold as an investment. Bitcoin is one of the most well-known cryptos, but there are thousands of popular coins, such as Ether and Solana. The estimated global cryptocurrency market cap is currently near $4 trillion.
To understand how cryptocurrencies work, you should get familiar with their underlying technology, known as a blockchain. Blockchains are decentralized databases that have many uses, including powering cryptocurrencies.
One of the first blockchains was developed for Bitcoin. However, other crypto networks, such as Ethereum, are powered by their own dedicated blockchains.
Blockchains verify crypto transactions and store data in secure, distributed databases spread across many computers worldwide. Therefore, no one person or organization owns or manages public blockchains, making them very difficult for hackers to manipulate.
While blockchain transactions are fully transparent, crypto is anonymous. You can buy, sell, and exchange it without revealing your personal information or identity. Many people purchase crypto because they believe its price will increase despite extreme volatility.
Bitcoin is unique because its code allows a total of 21 million coins. Many investors buy and hold Bitcoin because they believe its limited supply will cause the price to rise significantly over time.
How is cryptocurrency taxed?
Crypto gets taxed like any other asset, such as mutual funds, where you must pay capital gains tax when you realize a gain. For example, if you buy a crypto coin for $100 and sell it for $150, you must pay tax on $50 of profit.
Also, buying something with crypto or trading crypto that’s increased in value is a taxable event.
Let’s say you purchased one Bitcoin for $40,000 several years ago. Now, it’s worth $100,000, and you use it to buy a car. You’d have a $60,000 capital gain to report.
But if you buy and hold crypto, that isn’t a taxable event. You only owe tax when you sell, spend, or trade crypto that’s risen in value, or you get paid interest on crypto you own. Selling crypto for a loss can offset your capital gains up to annual limits, just like other assets.
What are cryptocurrency capital gains taxes?
Capital gains tax rates depend on your tax filing status, income, and length of time you own an asset. If you own a coin (or other assets) for a year or less and sell it for a profit, you owe short-term capital gains tax, which is the same as ordinary income taxes.
Federal taxes are graduated, so you pay different rates on different amounts of income. They range from 10% to 37%, depending on your taxable income and tax filing status.
However, if you own a coin for over a year, you owe long-term capital gains tax, which ranges from zero to 20%, depending on your income. So, holding assets for longer than a year is a wise strategy for cutting taxes, especially if you’re a high earner. You must report crypto gains and losses on Form 8949.
Taxable options to invest in cryptocurrency
Here are some taxable ways you can invest in cryptocurrency:
- Crypto exchanges. Using a cryptocurrency exchange is an easy and popular way to buy and sell crypto. Just open and fund your account, then choose the crypto you want to own.
- Crypto savings accounts. Many crypto exchanges allow you to earn interest on specific coins. Like bank savings, the institution lends out your deposits and pays you interest. You can receive earnings in the crypto of your choice. However, unlike a regular savings account, your money isn’t FDIC-insured up to certain limits.
- Crypto-rewards credit cards. If you’re unsure about buying crypto, you can earn it using a crypto rewards credit card. You receive crypto based on your spending or earn points to convert to cryptocurrency.
Tax-friendly options to invest in cryptocurrency
An excellent way to avoid capital gains tax on crypto is owning it in one of the following three tax-advantaged accounts.
1. Crypto retirement accounts.
A workplace retirement plan offering crypto or a crypto IRA is an excellent way to buy and sell crypto because you avoid capital gains tax. With a traditional account, your contributions are tax-deductible, and you pay ordinary income tax on amounts withdrawn in retirement. Contributions are taxable with a Roth account, but withdrawals (including all investment growth) are tax-free in retirement.
For 2024 and 2025, the annual contribution limit for a regular or crypto IRA is $7,000 or $8,000 if you’re over 50. Anyone with earned income is eligible for a traditional IRA. However, there are annual income limits to qualify for a Roth IRA.
For 2024, the contribution limit for most workplace retirement plans is $23,000, or $30,500 if you’re over 50. The limit will increase to $23,500 and $31,000 in 2025. However, starting in 2025, participants aged 60 to 63 qualify for an additional “super catch-up” contribution of $11,250, for a total of $34,750.
2. Crypto Coverdell Education Savings Accounts (ESAs).
A Coverdell ESA is a great way to save for a child’s education, from kindergarten through graduate school. You can open a self-directed ESA and invest in crypto.
Contributions to a Coverdell get taxed, but withdrawals are tax-free if you use them for qualified education expenses, such as tuition, books, equipment, and supplies. There’s an annual income limit to qualify for Coverdell contributions, and you can save up to $2,000 per student per year.
3. Crypto Health Savings Accounts (HSAs).
Using a health savings account to save for current and future healthcare expenses is one of the best financial moves you can make. They give you the following tax benefits:
- Tax-deductible contributions
- Tax-free investment growth
- Tax-free withdrawals (if you spend them on qualified healthcare expenses)
You can open a self-directed HSA and invest in crypto. However, to qualify for the account, you must be enrolled in an HSA-eligible health plan.
For 2024, you can contribute up to $4,150 or $8,300 if you have a family health plan. The limit increases slightly for 2025 to $4,300 or $8,550. And if you’re over 55, you can contribute an additional $1,000 annually.
Should you invest in cryptocurrency?
Whether you should invest in crypto depends on various factors, including your risk tolerance, retirement time horizon and comfort with or knowledge of the technology. Crypto is speculative and volatile.
Maintaining a diversified investment portfolio that insulates you from market downturns is always wise. If you want to own crypto or any alternative investment, consider making it a small percentage of your overall portfolio, such as no more than 3% to 5%. Limiting your exposure allows you to profit from the upside without taking too much risk.
