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How Is Crypto Taxed?
By Aja McClanahan MONEY RESEARCH COLLECTIVE
Cryptocurrency is arguably one of the most exciting, mysterious and befuddling financial products of our time. The sheer novelty of this new asset class continues to raise more questions than answers, and understanding how crypto is taxed is a common concern.
Despite the term “currency” in the name, the IRS treats cryptocurrency as property that is taxed as such. According to the Internal Revenue Service’s (IRS) website, “Virtual currency transactions are taxable by law just like transactions in any other property. Taxpayers transacting in virtual currency may have to report those transactions on their tax returns.”
If you’re one of many millions of Americans investing in cryptocurrency, there’s plenty you need to know about tracking and reporting your crypto activity for tax purposes. Here’s a quick guide to help you get started.
Table of contents
Crypto taxes guide
Logan Allec, a CPA and founder of the personal finance blog Money Done Right, has worked with many crypto investors who’ve already run afoul of IRS tax regulations for cryptocurrencies. Consequently, his firm helps taxpayers negotiate large tax bills related to their cryptocurrency holdings.
He encourages owners of crypto assets to stay on top of their potential tax liabilities and reminds investors, “Make sure you answer the cryptocurrency question on your tax return,” adding that, “Falsely answering this question is considered perjury, punishable by up to three years in federal prison and/or a fine of up to $250,000.”
Cryptocurrency, although a newer asset, still follows many of the familiar tax rules covering ordinary income and assets, so filing your taxes as a crypto investor could be simpler than you think. Like existing IRS rules regarding property and income, much of your tax liability will depend on your personal circumstances like filing status, tax bracket and how long you’ve held your crypto.
Your biggest challenge might be recognizing, tracking and properly reporting crypto taxable events. Once you get a handle on these more administrative activities, filing your taxes will be much easier.
When do you have to pay taxes on crypto?
There are only a handful of crypto-related activities that trigger a tax liability. Though you can check out the IRS resource on virtual currencies for the more granular details, we’ve summed up the most common activities below:
Sell for profit or loss
When you sell cryptocurrency for more than you paid for it, you will owe taxes on the gain (profit). You’ll report this profit on your tax return, and the IRS will either tax it as regular income or as a capital gain. As we’ll see below, which category it falls into depends on how long you’ve held your crypto.
If you had a capital loss from selling cryptocurrency, the IRS allows you to deduct up to $3,000 in net losses against your W-2 income. Many investors use this strategy, known as tax-loss harvesting, to offset capital gains in a current tax year and, in some cases, against capital gains in the future.
Earn income from mining
Mining is the process of validating cryptocurrency transactions. When miners use their computing resources to solve the complex equations required to verify these transactions, they are rewarded with a small amount of cryptocurrency.
This compensation is recognized as ordinary income by the IRS and taxed accordingly. As a miner, you’d pay taxes on the fair market value of your mined coins at the time of receipt.
Earning staking rewards
Staking allows you to earn rewards by holding cryptocurrencies. The IRS treats staking rewards like ordinary income, so you must report it and pay taxes on it.
Crypto airdrop
When you receive cryptocurrency tokens as a gift, this is known as an airdrop. Some companies offer these complimentary tokens to promote their coins for wider adoption. You’ll pay the ordinary income tax rate on the fair market value of these coins when you receive them.
Exchanging crypto for another
If you are swapping one cryptocurrency for another, you’ll report a capital gain or loss for tax purposes. Note that transaction fees incurred while buying and selling cryptocurrencies will adjust your basis and, as a result, your capital loss/gain figures.
Here’s a simplified example that doesn’t consider these fees but still demonstrates the concept of exchanging your crypto and how capital gains and losses work. Say you purchased $500 worth of Bitcoin (BTC) with Ethereum (ETH) that you originally purchased years ago for $100. This swap would result in a $400 long-term capital gain on your ETH, and you would establish a $500 basis in your BTC. If the value of your Bitcoin drops to $300 shortly after your purchase, and you liquidate that $300, you’d realize a $200 short-term capital loss on your BTC.
Buying goods and services with crypto
If you exchange your crypto for goods and services, you’ll also have to report a capital gain or loss. Your gain or loss is the difference between the fair market value of the goods or services you received and the cost basis of your cryptocurrency.
Let’s say that you purchased 1 ETH for $1,000. A few years later, your ETH is worth $2,500. Then, you use it to purchase a rare stamp collection for $2,500 worth of ETH. Your capital gains on this transaction would be the $2,500 you paid for the stamp collection less your cost basis of $1,000. In this case, your gain (profit) would be $1,500, subject to a long-term capital gain tax.
When do you not have to pay taxes on crypto?
Buying and holding
When you buy and hold an asset that appreciates, these are known as unrealized gains. This means that technically your asset is more valuable than when you purchased it, but you haven’t converted that gain to fiat, another cryptocurrency or used it to pay for goods and services. Therefore, there are no taxes due.
Donating crypto to charity
When you donate crypto to charity, the IRS recognizes it as a non-cash donation. If you are donating cryptocurrency to qualified charitable organizations, you won’t recognize any income, gain, or loss.
If you’ve held your crypto for more than a year, your charitable contribution deduction is equal to the fair market value of your currency at the time of the donation. If you held your currency for less than a year, your deduction will be equal to your basis in the currency or the currency’s fair market value at the time of the contribution, whichever is less.
When do you have to pay taxes on crypto?
When you sell an asset (such as stock, real estate or even a business) for a profit, a portion of that profit will be taxed at either short-term or long-term capital gains rates. If you’ve held the asset for less than a year, it’s subject to short-term capital gains taxes, or the same as the income tax you pay on your employment wages, also known as ordinary income. The current earned income taxes are between 0% and 37%.
If you’ve held your crypto longer than a year, your gains are taxed at long-term capital gains rates of 0%, 15%, and 20%, depending on your income.
How do you file crypto taxes?
If you are a U.S. citizen required to file taxes here in the states, you’ll report your crypto activities on your 1040 form by answering the virtual currency question at the top. If you have losses or gains to report, you will do that on Form 8949.
Allec clarifies when to answer yes or no to the virtual currency question, “If the only cryptocurrency transactions you made during the year were ones involving purchases of cryptocurrency with fiat money, such as United States dollars, you can answer this question ‘No’. If you did anything else with cryptocurrency — sold it for fiat money, exchanged it for other coins, received an airdrop, etc. — you must answer this question ‘Yes’.”
Once you report all of your crypto-related activities, you can file your income tax return as you normally would. As of 2022, you can get your tax refund in crypto by connecting your TurboTax and Coinbase accounts.
How to keep track of crypto for taxes?
Tracking and reporting information regarding all your crypto activities could become overwhelming, if not impossible. Although you may get some reports and forms from your crypto exchanges, don’t depend solely on that for taxes. Not all exchanges report to the IRS or give tax forms, such as a 1099, related to your crypto activity. Ideally, you’ll use platforms that aggregate all the information you need in one place.
CoinLedger, Koinly and CoinTracker are examples of reporting services that sync with various crypto exchanges and accounting apps to provide the reports you need for tax purposes. Like all other tax-related information, you should keep your source files and records in case the IRS requests them for verification.
Crypto taxes latest news
At the time of this writing, many cryptocurrencies and related assets, like NFTs, are experiencing a steep decline in value. When this happens, cryptocurrency investors should avoid common mistakes like:
- Not staying on top of the latest cryptocurrency regulations and developments
- Not properly tracking cryptocurrency activities and taxable events
- Not reserving enough gains in fiat currency to cover taxes
- Trading with too much leverage
Make sure you work with a trusted financial professional so you know the tax implications of trading and cashing out on volatile assets like cryptocurrencies.
Crypto Taxes FAQ
How can I avoid capital gains tax on cryptocurrency?
What happens if you don't report cryptocurrency on taxes?
How much tax do you pay on crypto gains?
Aja McClanahan is a writer that covers personal finance and a number of related topics. Her work and personal story of paying down over $120,000 in debt have been featured in publications around the web including sites like Money, CreditCards.com, Business Insider, Inc., Experian and many others.