Crypto, Losses, Capital Gains? How To Think About Taxes in Investment Decisions

In April of 2021, Trevor Lawrence, the first pick in the NFL draft, was rumored to take his entire $22 million dollar signing bonus in a crypto account, thereby calling into question the old adage, “No one goes broke paying taxes.” 

This would not have caused Lawrence to go broke, but it temporarily sacked his balance sheet. Simple math: $22 million means $11 million in taxes owed, and roughly a 28% drop in Bitcoin since April of 2021 leaves him a little less than $5 million. 

But rather than set up a Go Fund Me campaign for the young millionaire, let’s explore some things about taxes that are generally — but not always — true.

Defer your taxes as long as possible. All things being equal, this is one of the most sensible 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 — least of which your tax rate. For example, if you know that you are going to be moving to a low-tax state, you need to factor your state income tax savings in your tax rate calculations. But If you are going to be in a higher tax bracket in the future, you don’t want to defer low taxes today only to pay more of them tomorrow. 

This is especially true for those who have built up retirement plan assets, which usually have to come out at age 72 (with a proposal to delay the required minimum distribution age to 75). 

If you just let those accounts accumulate, you will have higher required withdrawals when you reach those ages. This may not only 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 guide you in deciding when to start taking money out of your retirement plans to normalize your tax rates. If you don’t need the money that you are pulling out, convert it to a Roth IRA so you are turning low-taxed money into no-taxed money.

You can only use $3,000 of losses a year. Don’t underestimate the value of tax losses, especially in a year where your portfolios may have fallen. 

While it’s true you generally can’t take capital losses of more than $3,000 in a single year, all losses offset all gains in any particular year. This means that if your stock or mutual fund has fallen, consider swapping into a similar investment and grabbing the tax loss. 

If the investments are not identical, you can stay invested but bank the loss. If you want to still own the stock, then you can buy it back after 31 days to avoid wash-sale rules. Make sure you consider transaction costs as you harvest losses.

If you are sitting on a bunch of losses that you can’t use this year, they get carried forward into future years. But again, because of inflation, the value of those losses decay over time. 

You can use those losses sooner by selling investments in which you have gains. If you still like the investment with a gain, you can buy it immediately back. Wash sales are only an issue for losses, not gains. Buying it back establishes a new, higher basis — thereby reducing future taxes when you sell it. 

You’re not getting a benefit from your charitable contributions because you don’t itemize. Unless you have a lot of mortgage interest, health care costs and state income and property taxes, it is more difficult to itemize your deductions. The way to get the most bang out of your charitable buck is to bunch a few years worth of gifts 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 stock held more than a year because you avoid the capital gains on selling the stock and gifting the proceeds. You get your deduction at the time of your gift, but it can sit in the donor-advised fund until you want to use it. An even better idea for those 70.5 or older is to gift directly to charities from your retirement plan.

If Lawrence did have all those crypto losses, I hope he was able to use some of these tax tools we discussed to take advantage of them.

Related: We’re All Paying the Volatility Tax Right Now