While crypto taxes can be complicated, the key principles are not. Fix these ideas in your head:
- Selling crypto.
- Trading crypto.
- Buying stuff with crypto.
- Receiving crypto from airdrops, hard forks, staking rewards, and the like.
Not taxable events:
- Buying crypto.
- Donating crypto to a tax-exempt organization.
- Gifting cryptocurrency (though large gifts may trigger a gift tax)
- Transferring crypto from one address to another.
How is Crypto Taxed by the IRS?
In the US, the Internal Revenue Service (IRS) treats cryptocurrency as property, suggesting that crypto income and capital gains are taxable events, while crypto losses may be tax deductible.
Note that most major centralized crypto exchanges operating in the US are reporting to the IRS. With KYC rules implemented across all reporting exchanges, crypto traders should never ignore their crypto tax obligations.
The IRS treats digital currencies as subject to rules on capital gains and losses, similar to stocks. When you purchase cryptocurrency, the original cost becomes its basis. Once you sell it, you are taxed based on the difference between the basis and the sale price.
Capital gains and losses are calculated based on the net total of all transactions in a year. For example, if you sold four different cryptocurrencies for a net profit of $2,000 and two digital assets for a loss of $6,000, you would end up with a net capital loss of $4,000.
You can deduct up to $3,000 in capital losses from your taxable income each year and carry over any remaining losses to the following years. For instance, a net capital loss of $4,000 in 2022 allows you to deduct $3,000 from your taxable income that year and apply the remaining $1,000 to your 2023 taxes.
The tax rate for capital gains depends on how long you hold the asset before selling it. If you hold your cryptocurrency for less than a year, then you’re subject to short-term capital gains. Otherwise, long-term capital gains apply, and the taxes in this case come at a significantly lower rate compared to short-term gains. Nevertheless, your exact tax rate will depend on your filing status and taxable income, and you may not have to pay any capital gains tax at all.
Necessary Crypto Tax Forms
To begin with, crypto exchanges like Coinbase send Forms 1099-MISC (miscellaneous income) to traders who earn $600 and up through crypto rewards and staking. These forms are also sent automatically to the IRS. The Infrastructure and Investment Jobs Act enforced by the Biden administration in November 2021 will require crypto exchanges to issue a 1099-B (Proceeds from Broker and Barter Exchange Transactions) beginning this year.
To report crypto on your taxes, you have to fill out the following forms and attach them to your Individual Income Tax Return Form 1040 (which is used to determine the total taxable income):
- Form 8949 – this form is used to report capital gains or losses from selling or disposing of your crypto.
- Form Schedule D (1040) – this form is used to report the overall capital gains and losses. You should list the totals for your short- and long-term capital gains and losses separately here.
- Form 1040 Schedule 1 – while crypto profit is often reported as capital gains, it can also be regarded as ordinary income when it comes from mining and staking, airdrops, hard forks, and lending interest. This form covers the mentioned instances.
- Form 1040 Schedule C – if you received crypto in the form of salary as a self-employed person (freelancer), you must fill in Schedule C.
Finding Your Tax Basis
Defining the tax basis is essential, given that it’s used to determine the amount of capital gains or losses. As a rule, the tax basis of cryptocurrency is the amount at which it was purchased, including exchange or transaction fees.
It makes sense to keep a record of your cost basis in order to ensure the accuracy of your capital gain or loss. No problem if you have no record: you can make an estimate by looking up the historical price of the asset at the time of purchase.
For crypto obtained from mining or staking, the cost basis is determined by the fair market value at the time you received the crypto.
Crypto Tax Types
Besides the profits made from price fluctuations, there are other crypto taxes that you should know about:
The crypto generated through mining is taxed as income when earned and as capital gains when sold. If you hold the mined crypto, the capital gain will be calculated based on the cost basis at the time of mining. Individuals can report the crypto mining tax on their Form 1040 Schedule 1 on Line 8 as “Other Income.” Crypto mining businesses are eligible to deduct certain costs, such as electricity and equipment.
The crypto funds received from an airdrop are taxed as regular income, which is reported as the value of the asset when it comes into your possession.
When you sell or trade an airdropped asset, you have to report the capital gains tax on any growth in its value from the time of receipt to the time of disposal.
Taxes on Forks
Similar to airdrops, crypto funds resulting from hard forks are taxed as regular income at their fair market value (FMV) at the time they were deposited into your wallet.
If you receive crypto as a gift, you won’t be taxed unless you take part in another taxable event, such as staking.
Also, you have the option to gift a maximum of $15,000 per person annually without incurring any taxes (with a higher limit for gifts to spouses). Going beyond that limit will require you to submit a gift tax return, although this usually doesn’t lead to immediate tax obligations.
Cryptocurrency Taxation Example
Here is an example of crypto taxation with events arranged chronologically:
|Event||Crypto holdings||Net fiat invested||Cost basis||Market value|
|1||Bob buys 0.5 BTC for $5,000||0.5 BTC||$5,000||$5,000||$5,000|
|2||Bob participates in a mining pool and receives $0.1 BTC||0.6 BTC||$5,000||$6,000||$6,000|
|3||Bob receives a gift of 100 USDC||0.6 BTC, 100 USDC||$5,000||$6,100||$6,100|
|4||BTC price increases from $10,000 to $20,000||0.6 BTC, 100 USDC||$5,000||$6,100||$12,100|
|5||Bob moves his 0.6 BTC to a safer wallet||0.6 BTC, 100 USDC||$5,000||$6,100||$12,100|
|6||Bob decides to cash in and sells all of his BTC holdings for $12,000||100 USDC||-$7,000||$100||$100|
Analyzing all the steps during the year:
- Bob buys 0.5 BTC, no taxable event.
- Bob receives 0.1 BTC from mining, which is a taxable event and is treated as ordinary income.
- Bob receives 100 USDC as a gift, no taxable event.
- Prices go up, but no assets are disposed so there is no taxable event.
- Bob moves crypto holdings between his wallets – no taxable event.
- Bob sells his BTC receiving a net income of $7,000.
Therefore, Bob has accumulated $6,000 of capital gains and $1,000 of ordinary income (from crypto mining).
Crypto Tax Loss Harvesting
Investors use crypto tax loss harvesting as a strategy to reduce overall tax liability. They do this by selling crypto assets at a loss during market downturns or at the end of the tax year, effectively reducing their overall tax obligation by offsetting other capital gains.
This method allows for an unlimited number of assets to be sold at a loss, and if capital losses exceed capital gains, up to $3,000 per year can be claimed as a deduction to reduce ordinary income. As mentioned earlier, any remaining losses can be carried over to offset capital gains or income in future tax years, providing an ongoing benefit.
Cryptocurrencies may be even better candidates for tax loss harvesting than stocks, as they don’t fall under the wash sale rule imposed by the IRS. It prevents investors from claiming capital losses and instantly buying back the same stock. The wash sale rule currently applies only to securities, as per IRS guidelines, while cryptocurrencies are treated as property.
What Happens if You Don’t Report Cryptocurrency on Taxes?
In the US, it is mandatory to file taxes, and failure to do so may result in penalties, interest, confiscated refunds, audits, and even imprisonment. This applies even if you do not owe any taxes or are eligible for a refund.
Crypto Tax Help is Available
Managing and monitoring cryptocurrency transactions can be a complex process, particularly when conducting hundreds or thousands of trades during the year. This is where crypto tax services come into play. These software tools are designed to sync with exchanges and wallets to automatically track and calculate gains and losses. You can use these programs to automatically generate a tax report that can be used to file with the government, simplifying the entire process for cryptocurrency traders.
Check our dedicated article discussing the best crypto tax packages, including Cointracker, TaxBit, CoinTracking, and Accointing, among others.
Sell and trade as little as possible. Remember that most governments treat crypto as property, so every sale and trade is a taxable event. This means you either have to pay taxes on the profits (capital gains), or you can possibly claim the loss (capital losses).
However, buying crypto is free.
You don’t pay tax on purchases, which is why steady-drip investing is so powerful. You can keep investing in crypto for as long as you like and only pay taxes when you cash out. Traders have to endure a tax nightmare, while long-term hodlers can sleep well at night.
In other words, KISS (Keep It Simple, Silly).
- A buy-and-hold approach…
- With a monthly contribution…
- On a trusted wallet or exchange…
- Can reduce your tax prep to the bare minimum.
Cash out only when you’re ready, pay taxes on the gains, and you’re done.
Do I need to report my cryptocurrency transactions on my tax return?
Cryptocurrency transactions are taxable events and you have to calculate gains or losses from all transactions during a year and include them in your tax report.
How are cryptocurrency gains and losses taxed?
Short-term crypto gains on assets held for less than a year are subject to tax rates similar to all other income, which can range from 10% to 37%, depending on your federal income tax bracket. Holding crypto for more than a year would reduce the tax rate, which can range from 0% to 20%. Losses are not taxed.
Can I deduct cryptocurrency losses on my tax return?
Yes. Losses can offset gains from other crypto assets. Once total losses exceed total gains, you can reduce up to $3,000 from your regular income.
How do I calculate my cryptocurrency gains and losses?
The capital gains or losses from crypto trades are calculated based on the cost basis, which is the initial price paid for crypto or the asset value at the time of the purchase. When selling crypto, subtracting the cost basis from the sale price determines the amount of capital gain or loss.
What if I lost access to my cryptocurrency or my cryptocurrency was stolen?
Although the IRS does not offer clear guidance on how to tax lost or stolen cryptocurrency, you may be eligible for a tax exemption if you treat the lost or stolen crypto as an investment loss. It is recommended to seek advice from a crypto tax specialist.
Once your tax issues are sorted, it’s time to learn more about investments. Subscribe to the Bitcoin Market Journal newsletter today!