Levin: Crypto, losses, capital gains? How to Consider Taxes in Investment Decisions
In April 2021, NFL No. 1 draft pick Trevor Lawrence reportedly took his entire $22 million signing bonus to a crypto account, challenging the old adage “Nobody goes broke by paying taxes”.
It wouldn’t have bankrupted Lawrence, but it temporarily wrecked his balance sheet. Simple math: $22 million means $11 million in taxes owed, and a roughly 28% drop in Bitcoin since April 2021 leaves it just under $5 million.
But rather than setting up a Go Fund Me campaign for the young millionaire, let’s explore some things about taxes that are usually — but not always — true.
Defer your taxes for as long as possible. All things being equal, this is one of the smartest tax decisions you can make. Because of inflation, a dollar paid tomorrow is worth less than a dollar paid today.
But all things are not equal – including the lower your tax rate. For example, if you know you will be moving to a low-tax state, you should factor your income tax savings into your tax rate calculations. But if you’re going to be in a higher tax bracket in the future, you don’t want to defer low taxes today to pay more tomorrow.
This is especially true for those who have built up retirement assets, who generally have to exit at 72 (with a proposal to delay the required minimum distribution age to 75).
If you simply let these accounts accumulate, you will have higher required withdrawals when you reach these ages. Not only can this affect your federal tax rate, but it could cause you to pay more for Medicare, affect how your Social Security income is taxed, and create higher capital gains rates.
Running various tax scenarios can help you decide when to start taking money out of your retirement plans to normalize your tax rates. If you don’t need the money you withdraw, convert it to a Roth IRA to turn low-taxed money into tax-free money.
You can only use $3,000 in losses per year. Don’t underestimate the value of tax losses, especially in a year when your portfolios may have fallen.
While it’s true that you generally can’t sustain capital losses of more than $3,000 in a single year, all losses outweigh all gains in any given year. This means that if your stock or mutual fund has fallen, consider exchanging it for a similar investment and capturing the tax loss.
If the investments are not identical, you can stay invested but take the loss. If you still want to own the stock, you can redeem it after 31 days to avoid wash sale rules. Be sure to consider transaction costs when reaping losses.
If you’re sitting on a pile of losses that you can’t use this year, they carry over to future years. But again, because of inflation, the value of these losses decreases over time.
You can use these losses sooner by selling investments in which you have gains. If you still like the investment with a gain, you can redeem it immediately. Wash sales are only a problem for losses, not gains. Buying it back establishes a new, higher base, reducing future taxes when you sell it.
You don’t get any benefit from your charitable contributions because you don’t detail. Unless you have a lot of mortgage interest, healthcare costs, and income and property taxes, it’s harder to itemize your deductions. The way to get the most out of your charitable money is to consolidate a few years of giving into one year through a donor-advised fund at a foundation or brokerage firm.
You even get a bigger tax advantage if you fund it through appreciated shares held for more than a year, because you avoid capital gains on selling the shares and donating the proceeds. You get your deduction when you donate, but it can stay in the donor-advised fund until you want to use it. An even better idea for people age 70.5 or older is to donate directly to charities from your retirement plan.
If Lawrence took all those crypto losses, hopefully he was able to use some of those tax tools we discussed to capitalize on them.
Ross Levin is the founder of Accredited Investors Wealth Management in Edina.