Cryptocurrency is the Wild West of the investment world. Not only are these digital currencies completely nontangible, but they fluctuate with such volatility that trading and investing in them can feel more like playing a video game than investing in a real asset class.
But from a tax perspective, the IRS views cryptocurrency transactions the same as if you were buying or selling stocks, bonds or other financial assets. Here are the important tax-related things you need to know about cryptocurrency, whether you trade it or simply use it to buy your morning coffee.
Yes, Cryptocurrency Is Taxable
Let’s cut right to the chase — yes, cryptocurrency can be taxable, depending on what you do with it. The IRS views cryptocurrency as a capital asset, meaning there are taxes to be paid on any gains. But other actions can also trigger tax on cryptocurrencies, and you should be prepared to declare any such transactions when you file your taxes.
What is cryptocurrency
According to the IRS, a cryptocurrency is any type of digital currency that uses cryptography (a method of securing information) and is on a distributed ledger (a database that is shared and synchronized across multiple sites). The most common ledger for virtual currency transactions is blockchain.
On tax forms and instructions, the IRS will commonly use the term virtual currency instead of cryptocurrency. Popular types of cryptocurrency include bitcoin, Dogecoin, ether (Ethereum), XRP (Ripple), Litecoin (LTC), Tether, (USDT), and Libra.
How cryptocurrency taxes work
As a United States citizen, you owe taxes on the income you earn worldwide. Most people hold cryptocurrency as an investment. Under the current Internal Revenue Service virtual currency guidelines, cryptocurrency is most often treated as a capital asset. This means the tax you pay on it is capital gains tax. (Cryptocurrency may also be received as income, which we share more about in a bit.)
You pay capital gains taxes depending on the type of capital gain you have. The two types are short-term and long-term capital gains and are based on how long you hold the asset, in this case the cryptocurrency.
- Short-term capital gains occur when you sell cryptocurrency for more than you bought it and held the investment for a year or less. These are taxed at the taxpayer’s ordinary income tax rate, just like wage income.
- Long-term capital gains are realized when you sell cryptocurrency for more than you bought it but held the investment for longer than a year. These gains are taxed at more favorable long-term capital gains tax rates, which can be as low as 0%.
It’s essential to realize that virtual currencies are relatively new, and the IRS or Congress may change their stances on crypto taxes in the future. But based on the current taxation of cryptocurrency.
What does set off against long term loss means?
The current income tax laws allow taxpayers to set off their long term losses against long term capital gains. It exempts taxpayers from paying tax on their long-term gains. However, that won’t be possible in case of crypto income.
“It will be treated as a separate class of asset. Such proposed inclusion of tax provision in the income tax is a first step towards taxing the digital assets and it will be interesting to see the definition of virtual assets i.e. whether it will be restricted to only cryptocurrencies or will also include Non-fungible tokens and such other types,” Saurrav Sood, Practice Leader, International tax, SW India told India Today Tech.
If I gift my cryptocurrency, am I liable to tax?
When any item is donated or gifted for a value different than its acquisition cost, CRA will treat the donation or gift as a disposition of property. Accordingly, this applies to a gift or donation of cryptocurrency. The cryptocurrency will be valued at fair market value at the time of donation, and any capital gain or loss from the disposition must be reported. If the gift is made to a qualified donee (such as a registered charity), it may be possible to receive a tax receipt from that donee. The amount of the gift for tax purposes will be determined by the fair market value of the cryptocurrency at the time of the transfer.
How to report crypto on taxes
Crypto gains and losses are reported on Form 8949. To fill out this form, provide the following information about your crypto trades:
- Name of the cryptocurrency
- Date you acquired it
- Date you sold, traded, or otherwise disposed of it
- Proceeds or sales price
- Cost basis
- Total gain or loss
Repeat this process with every taxable crypto event you had for the year.
How is crypto income taxed?
Crypto income is taxed as ordinary income at its fair market value on the date the taxpayer receives it.
Here are the most common examples of what’s considered crypto income:
- Receiving crypto as payment for providing a service
- Mining crypto and earning rewards
- Staking crypto and earning rewards
- Lending crypto and receiving interest payments
Which Crypto Transactions Are Not Taxable?
It may seem like crypto taxes apply to everything, but there are a few things you can do without creating a taxable event. The following types of transactions do not create a tax burden (but you may still need to report them):
- Purchasing crypto with USD/fiat
- Holding crypto, even if the value increases
- Transferring crypto between your own wallets and exchanges
- Giving or receiving crypto as a gift (within limits)
- Donating crypto to a qualified nonprofit
What about NFTs?
The IRS has not released any specific guidance on NFTs. But generally speaking, the same tax principles that apply to trading cryptocurrency also apply to trading NFTs. For more information on specific scenarios, read our NFT taxes blog or contact our crypto tax lawyers!
What about DeFi?
Decentralized finance, or DeFi, creates a wide range of complicated tax questions. Although earning interest on DeFi loans might seem like a simple scenario, it actually depends on how things are structured on whichever DeFi platform(s) you’re using.
For example, getting protocol tokens/placeholder tokens in exchange for ETH can be considered a taxable crypto-to-crypto swap.
If you have complicated DeFi activity, we highly recommend hiring a tax professional to ensure you’re reporting crypto taxes correctly.
If you receive cryptocurrency as payment for goods or services
Many businesses now accept Bitcoin and other cryptocurrency payments. If someone pays you cryptocurrency in exchange for goods or services, the payment counts as taxable income, just as if they’d paid you via cash or check. For tax reporting, the dollar value that you receive for goods or services is equal to the fair market value of the cryptocurrency on the day you received it.
If you sell or spend cryptocurrency
If you mine, buy, or receive cryptocurrency and eventually sell or spend it, you have a capital transaction resulting in a gain or loss just as you would if you sold shares of stock. This is where cryptocurrency taxes can get complicated.
For example, let’s say you receive $200 worth of the cryptocurrency Litecoin in exchange for services on January 15. Six months later, on July 15, the fair market value of your Litecoin has increased to $400, and you use it to buy plane tickets for a vacation. On your tax return for that year, you should report $200 of ordinary income for receiving the Litecoin in January and a short-term capital gain of $200. That’s the $400 value of your Litecoin when you purchased the plane tickets, minus your $200 basis when you received the Litecoin.
Those two cryptocurrency transactions are easy enough to track. But imagine you purchase $1,000 worth of Litecoin, load it onto a cryptocurrency debit card, and spend it over several months on coffee, groceries, lunches, and more. If, like most taxpayers, you think of cryptocurrency as a cash alternative and you aren’t keeping track of capital gains and losses for each of these transactions, it can be tough to unravel at year-end.
How to report cryptocurrency on your tax return:
Step 1: Gather a list of all your exchanges and transactions (including any 1099 forms exchanges sent you)
Step 2: Calculate your capital gains and losses
Step 3: Fill out IRS Form 8949 for all events taxable as property
Step 4: Transfer totals from you 8949 form to your Form 1040 Schedule D
Step 5: Fill out any remaining cryptocurrency income on Form 1040
Short-term vs. long-term capital gains
Capital gains taxes are applied at both the federal and state (where applicable) level. They can be long-term or short-term, and how long you’ve held your crypto affects how much tax you’ll end up owing. If you held onto your crypto for more than a year before selling, you’ll generally pay a lower rate than if you sold right away.
Long-term gains are taxed at a reduced capital gains rate. These rates (0%, 15%, or 20% at the federal level) vary based on your income. Higher income taxpayers may also be subject to the 3.8% Net Investment Income Tax on their gains or other income.
Short-term gains are taxed at your ordinary income rate, which is usually a higher, less-favorable rate.
Remember, taxable events happen when you realize losses or gains, meaning you’ve sold your crypto by either selling for cash, converting to another crypto, or spending it on a good or service. The gains are unrealized if you still own the original shares.
Understanding your capital losses
You’ve realized a capital loss when you sold an asset for less than you paid for it. Losses can work to your advantage, though. You can use losses to offset other capital gains (including from non-crypto assets, like stocks) you may have had during the year on a dollar-for-dollar basis, potentially reducing your overall tax bill.
If you have more losses than gains or have no gains at all, the maximum amount of losses that you can declare each year to offset other income is $3,000. Any remainder carries over to subsequent years until the full amount of the loss is applied.
Investing money in crypto assets might result in significant gains if you purchased the assets before they drastically increased in value. If you’re lucky enough to experience this, then a little bit of tax planning might help you reduce the taxes you owe on your crypto gains. The list of ideas above could help you when speaking with a tax professional.
Keep in mind, cryptocurrency taxation is extraordinarily complex, and the tax implications might change in the future. For this reason, it’s always best to consult a tax professional such as a Certified Public Accountant (CPA). They can help you make sure you’re following the applicable tax rules while helping you minimize any tax you may owe.