Crypto Exit Strategy: 14 Ideas to Maximize Your Investment (2024)

Timing is everything when it comes to creating a crypto exit strategy — and this is especially true for cryptocurrency investors. Planning a crypto exit strategy is difficult in this volatile market, which can see swings like the one of Bitcoin from $20,000 in December to almost $65,000 in April 2021.

If you can’t control the timing of the market, you can take steps to ensure that your exit strategy delivers the highest possible return on investment. The best crypto exit strategy takes into account capital gains tax, other liquidity options, reinvestment strategies, and tax-exempt accounts to ensure that you don’t see your returns disappear overnight.

Unfortunately, there’s no crystal ball that can tell you when the best time to maximize your return and minimize your tax burden is. However, there are exit strategies and best practices that you can follow that will help avoid taxes and fees and make your exit as valuable as possible. Here’s where to start.

1. Hold for at least a year

Ideally, you will plan your exit after your crypto investment has made significant gains. However, note that the tax you pay on capital gains depends on how long you held the asset before selling it. Capital gains, including gains on crypto, are classified as either short or long-term and taxed at different rates accordingly.

Short-term gains tax is the same rate that you would pay on your ordinary income. Depending on your federal tax bracket, that can be up to 37% in 2021. Long-term capital gains tax applies to assets that have been held for more than one year. The tax rate is according to graduated thresholds for taxable income: 0%, 15%, or 20%. Most taxpayers who report long-term capital gains don’t pay more than 15%.

Bottom line: hold your crypto for at least a year to trigger the long-term capital gains tax rate, rather than see your investment disappear at the higher short-term capital gains tax rate.

2. Borrow using Aave or Compound

Aave is a decentralized finance protocol that allows you to lend and borrow cryptocurrency without going through a centralized third-party. When you lend money, you earn interest. Compound is a similar app that allows you to earn interest by providing assets to a shared liquidity pool or vice versa — you can borrow assets from that liquidity pool by posting collateral. Borrowings are paid back with interest.

Using AAVE or Compound for liquidity is a good alternative to selling a crypto asset. Interest rates tend to be relatively low — historically, 0.3-6% APY for the Compound USDC pool. You can borrow assets for a short period, pay a low-interest rate, and avoid paying any capital gains tax.

3. Use a combination of borrowing and holding for a better tax rate

If you are getting close to a year holding period, but you need to exit for liquidity, borrow from Aave or a Compound pool. Borrow for the duration of time, then repay your liquidity pool and complete your crypto exit strategy. This approach can help you reach the year deadline for a more favorable tax rate.

4. Take a write-off loss…and reinvest

If your crypto token price has dipped, consider selling the token to take the write-off loss. As long as you don’t have capital gains to offset the capital loss, you can use a capital loss as an offset to ordinary income up to $3,000 per year. Once you’ve written off the loss, rebuy the same token — crypto assets are currently not considered securities, so making this strategic move can help you maximize your investment potential.

5. Set up a charitable remainder trust

A charitable remainder trust (CRT) is a tax-exempt irrevocable trust that can reduce your taxable income. These trusts allow individual beneficiaries to draw a certain amount of income each year for a period of years or for their or multiple lifetimes and then donate any funds that remain in the trust to a designated charity.

Before you decide to sell your crypto assets, set up this structure so you can avoid paying taxes upfront and reinvest all of the money pre-tax. Here’s how this could work: imagine you had a cryptocurrency that you purchased for $0 and sold for $1 million. As a California resident, you would be obligated to pay 35% in long-term capital gains tax, leaving you with $650,000 to reinvest.

That’s a great result, but you could keep far more of your earnings by setting up a Charitable Remainder Trust. By setting up a trust, you can donate your $1 million. When the trust sells assets, it pays no taxes. This allows the trust to keep the entire $1 million available for reinvestment, rather than $650,000.

6. Take advantage of opportunity zones

An opportunity zone is designated by the IRS as an economic development tool to invest in distressed parts of the US. Opportunity zones aim to “spur economic growth and job creation in low-income communities while providing tax benefits to investors,” according to the IRS.

One crypto exit strategy could be to sell your assets and immediately reinvest the money into opportunity zones. There are a couple of benefits to this tactic. Those who invest in opportunity zones can elect to defer capital gains tax if they invest those gains amounts in a Qualified Opportunity Fund (QOF) — avoiding capital gains tax until they sell or exchange their QOF investment or Dec 31, 2026, whichever is earlier. Likewise, holding an investment in a QOF comes with additional tax benefits:

• If the investor holds the QOF investment for at least 5 years, the basis of the QOF investment increases by 10% of the deferred gain.
• If the investor holds the QOF investment for at least 7 years, the basis of the QOF investment increases to 15% of the deferred gain.
• If the investor holds the investment in the QOF for at least 10 years, the investor is eligible to elect to adjust the basis of the QOF investment to its fair market value on the date that the QOF investment is sold or exchanged.

Opportunity funds are not only a good way to exit crypto without high taxes, but also a great way to invest in communities in need.

7. Use charitable deductions to write off realized gains

By taking charitable deductions from a charitable remainder trust and charitable lead annuity trust, you can write off your realized gains significantly. The IRS allows for up to 50% of adjusted gross income to be deducted for charitable donations.

Alternately, consider donating the appreciated cryptocurrency. When an appreciated asset is donated, the asset’s fair market value is the amount used to reduce taxable income. In addition, if the organization is a qualified charitable organization, you won’t pay capital gains tax.

8. Invest from a Roth IRA

A Roth IRA allows qualified withdrawals on a tax-free basis if certain conditions are satisfied. Because Roth IRAs are funded with after-tax dollars, the contributions are not tax-deductible. But, as soon as you start withdrawing funds, this money is tax-free. If you plan ahead, this means you can invest in crypto using funds from a Roth IRA account — making any returns you receive upon exit tax exempt.

Note, however, that there’s a limit to who is eligible to contribute to a Roth IRA. If you earn over a certain threshold, you are not allowed to add to a Roth IRA. According to the IRS, the limit in 2022 for single individuals is $144,000; for married couples filing jointly, the limit is $214,000.

9. Maintain all transaction records

The best crypto exit strategy is also one that is easy. Maintain files of all your transactions to make your tax preparation that much more straightforward. Transaction records can show how long you’ve held each asset, helping you and your tax prep team understand where you’re subject to long-term or short-term capital gains taxes. Remember, an exit strategy isn’t just about the numbers: it’s also about keeping good records and avoiding the attention of auditors.

10. Keep up to date with the Wash Sale rule

The Wash Sale rule is an IRS rule that seeks to eliminate transactions in which the trader sells a security to realize a tax-deductible loss, only to invest in an identical security within the following 30 days. Currently, cryptocurrency investments aren’t subject to the Wash Sale rule; however, the Build Back Better Act, currently under debate in Congress, is likely to eliminate the Wash Sale loophole for cryptocurrencies.

What does this mean for your crypto exit strategy? If you expect capital gains in 2021, consider harvesting crypto losses to reduce your capital gains liability. If you don’t have capital gains, realized losses can reduce up to $3,000 of ordinary income per year.

11. Offset capital gains and losses

Consider using your capital gains and losses to offset each other. For example, use losses in one investment to offset crypto gains and vice versa. Note that short-term losses first can reduce short-term gains, and long-term losses reduce long-term gains. After that, net losses of either can offset the other. If you have a net loss, this can reduce ordinary income up to $3,000.

12. Navigate income years

If your income dips and rises from year to year, consider timing your exit strategy to sell an appreciated crypto asset until a lower-income year. You may be able to take advantage of a lower tax rate if you are selling at the short-term capital gains tax rate (remember, this is taxed at ordinary income). Alternately, if you anticipate your income rising the following year, consider accelerating gains to enjoy lower capital gains rates. Running a multi-year income and tax projection is key to strategizing the best time to make your exit.

13. Reduce your overall income

Reducing income in the current year is always a solid tax strategy. Finding smart ways to invest in write-off business expenses. 401k plans, IRAs, HSA, or by making donations to charitable organizations can lower your overall tax burden. Work with experts to find specific deductions and credits that become available from year to year. Ultimately, these steps can help move you toward a lower tax bracket and maximize your ROI when you choose to exit.

14. Choose the right tax lot method

Practice tax-smart selling: use crypto accounting software to identify the best specific cost basis of each asset to sell. Treat your exit plan like any accounting decision, and use FIFO (first in, first out), HIFO (highest in, first out) or a specific lot as recommended.

For more tips to help you create the best crypto exit strategy, check out our Crypto Guide with tons of resources on setting up charitable remainder trusts and more.

Next Steps

Contact the team behind this tax planning business to go through your specific questions. We can help you out!

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