Before you start investing in crypto, you need to understand the tax implications associated with it. Cryptocurrency tax laws aren’t fully established as of yet, and regulations regarding this brand new asset class are changing all of the time.
One thing is certain, though. You will need to pay taxes on cryptocurrency investments when you take profits, just like you would with other asset classes, such as stocks.
In the past, regulators overlooked crypto. But today, bitcoin, which started circulating in 2009, has evolved into a $3 trillion cryptocurrency industry. So regulators, including the IRS, are watching closely.
Keep reading our cryptocurrency tax guide below for everything you need to know before tax season.
Is Crypto an Asset?
What is cryptocurrency? Is it a currency, or is it an asset? In many ways, it’s both.
Bitcoin, the world’s first cryptocurrency, was launched as a way to enable digital, peer-to-peer payments without needing a middle man to facilitate the transaction, like a bank or credit card processor.
Bitcoin’s original is that of a currency. Today, you can use bitcoin, and hundreds of other cryptocurrencies, as a method of payment, buying goods and services.
But the price of cryptocurrency fluctuates relative to the US dollar. In the early days, you could buy a single bitcoin for a few US dollars. In November 2021, the price of one bitcoin reached an all-time high of $68,000.
Those are some serious gains. One could sell their bitcoin and collect a massive profit.
And that makes it a capital asset, just like that of a stock or a house.
Is Cryptocurrency Taxed?
Cryptocurrencies are decentralized by design. That means they exist irrespective of a central authority, such as a national government, a bank, or even a company.
Because of this decentralization, many falsely believe that you don’t pay taxes on cryptocurrency. But this assumption is very wrong.
Any time you have an asset that appreciates in value, and you sell it for a profit, you are liable to pay capital gains tax. This is true for a rental property, Tesla stock, bonds, fine art, cryptocurrency, or whatever new asset class may come out in the future.
Just because the government cannot control crypto, they can tax American citizens who collect gains on cryptocurrency.
In 2022 and beyond, when you go to file your tax return, you will be asked if you have owned or used cryptocurrency during the previous tax year. If the answer is yes, you will need to include your gains on your tax return, just like you would do if you sold some stocks.
Are Crypto Taxes Considered Capital Gains?
Cryptocurrency is considered property, otherwise known as a capital asset. When you sell that capital asset, you will be subject to capital gains taxes, just like when you sell stocks or real estate.
When you sell an asset, you’ll subtract the original purchase price from your sales price. That’s your net gain. Only your net gain is subject to capital gains tax.
So if you bought 1 bitcoin for $40,000, and sold it for $45,000, you would only pay capital gains tax on the $5,000 gain.
Long-Term vs Short-Term Capital Gains Tax
Capital gains tax rates are the same, whether you are selling stocks or crypto. Cryptocurrency doesn’t have its own tax rate.
The rate does differ depending on how long you have held an asset.
If you’ve held a crypto asset for less than one year, and sold it for a profit, you would pay short-term capital gains tax on the profit. Short-term rates are the same as your income tax bracket.
This means you’ll pay between 12% and 37% short-term capital gains tax, depending on your income bracket for the year.
If you hold an asset for at least one year, then you’ll pay long-term capital gains tax. These are usually lower than short-term taxes.
If you make less than $40,400 per year then you’ll pay 0% in long-term capital gains tax. You’ll pay 15% of your income is between $40,401 to $445,850. And you’ll pay 20% of your income is $445,851 or more.
The income limits are higher for those who are filing jointly.
This tax system favors long-term investors, as opposed to short-term traders. Many short-term traders end up losing money, or barely breaking even since they have to pay much higher taxes.
What About Losses?
If you sell crypto assets for a profit, you experience capital gains. If you sell for a loss, the opposite is true; a capital loss.
While nobody likes taking a loss, capital losses help to lower your tax burden, just like gains increase your tax burden. You’ll experience either short-term or long-term capital losses at the same rates as capital gains.
Many strategic investors, who know they are subject to heavy capital gains tax on their upcoming tax return, will intentionally sell some assets at a loss to help offset their gains and reduce their tax bill.
Short-term losses are first used to lower your short-term gains. After that, any additional short-term losses are used against long-term gains, and vice versa.
If there are still losses leftover, they can be used to offset up to $3,000 of standard income.
Intentionally taking losses is an advanced tax strategy and you may want to work with your tax advisor or CPA for the best results.
What Is a Taxable Event?
Up until now, cryptocurrencies and stocks have looked very similar in terms of capital gains taxes. But crypto is on another level, as there are far more crypto tax rules to be aware of.
With crypto, there are more ways to trigger taxable events.
For example, when you buy a stock, there is nothing you can do with a stock except hold it or sell it. There is no utility for stocks, other than for speculation and appreciation.
Once you sell it for US dollars, you trigger a taxable event.
With cryptocurrency, there are many ways to trigger a taxable event. When buy and then sell it for US dollars, you trigger a taxable event.
But you also trigger a taxable event when you trade one cryptocurrency for another. You can buy bitcoin with US dollars. Then you can trade your bitcoin for Ethereum at the current exchange rate.
Even though you haven’t “sold” your assets, you have triggered a taxable event.
What are some other instances where you will trigger a taxable event?
Making a Purchase With Crypto
Many crypto enthusiasts use their cryptocurrencies to make purchases for goods and services. This can be in-store or online.
And each time you make a purchase using crypto, you trigger a taxable event. Essentially, when you buy something with crypto, that crypto is converted into cash and given to the business you are patronizing. You are selling your crypto and using the money to purchase a product.
Getting Paid in Crypto
More and more people are now getting paid in cryptocurrency. Whether you work a normal job and opt to receive your paycheck in crypto, or you are self-employed and receive your earnings in crypto, you may have to pay taxes twice.
When you first receive crypto as payment, it’s treated as income. You’ll pay regular income taxes on the deposit in your crypto wallet.
Then when you go to sell that crypto, you’ll trigger a taxable event. The net gain or loss is calculated based on the price of the asset at the time of deposit into your account.
So if you receive $5,000 in bitcoin as payment for a service you provided, and that bitcoin appreciates in value to $5,500 by the time you sell it, you’ll pay taxes on the $500 gain.
Receiving a Gift in Crypto
Crypto gifts are treated the same as other types of gifts. So if a gift is over $15,000 in 2021 or $16,000 in 2022, then it’s subject to the gift tax.
When the recipient sells the crypto, their cost basis will be the same as your cost basis when you gave them the crypto.
Other Crypto-Based Activities
There are other ways to receive cryptocurrency that will be subject to regular income tax.
Staking is the act of locking up some of your cryptocurrency in exchange for interest. When you earn interest on staked crypto, you’ll pay standard income taxes on it.
Airdrops occur when you receive crypto at random from a company, or through a giveaway. This is also taxed as ordinary income.
Mining is similar but has some nuances to understand. Mining cryptocurrency is the process of creating more crypto, adding it to the existing circulation, and receiving a reward for doing so.
Hobbyists will pay ordinary income taxes on crypto earned through money. However, mining can also be a business operation.
Since it costs money, in the form of equipment and electricity, to mine crypto, those expenses may be tax-deductible.
In order to enjoy these deductions, the mining operation must be run like a business.
What About NFTs?
Non-fungible tokens (NFTs) saw massive rates of adoption as the NFT market swelled to $23 billion in 2021. More and more people are buying and selling them.
Do you pay taxes on those as well?
NFTs are tokens that live on the blockchain. They are fundamentally similar to cryptocurrencies. They are considered property. You’ll pay the same capital gains taxes on NFTs as you would crypto.
When Don’t You Trigger a Taxable Event?
It seems like everything you do with cryptocurrency incurs taxes. And that’s almost true.
The only time you don’t pay taxes is when you buy and hold crypto, or when you transfer crypto from one wallet you own to another wallet you own.
If you have 3 crypto wallets, and you regularly move crypto between them, you won’t trigger taxable events.
Does the IRS Know About Your Investments?
If you use a centralized cryptocurrency exchange, such as Coinbase, Binance, Gemini, or others here in the US, they will inform the IRS that you have purchased cryptocurrency.
But their reporting to the IRS is limited. They won’t provide them with full reports of your investments and sales.
Rather, the IRS will know that you’ve invested in crypto and will expect to see it listed on your tax return when you file online. In recent years, they have been going after investors who have tried to avoid paying tax on their crypto investments.
If you’d like to avoid a notice from the IRS, then make sure to report your earnings when you file.
How to Manage Cryptocurrency Tax
With so many opportunities to trigger taxable events, it can be very difficult to keep track of your tax obligations. But it’s your responsibility to tell the IRS about your crypto gains as a result of every single transaction you make.
How can you do this?
One option is to simplify your crypto investing. Think like a long-term investor. Just buy and hold.
If you only ever make one or two sales in a year, then your reporting becomes much easier. With only a few sales to document, you can do so by hand.
It’s also easier if you only use one crypto exchange, rather than invest through multiple exchanges. Each exchange offers you an annual report which can be sent to the IRS to prove your income statement is accurate.
Crypto Tax Software
For many crypto enthusiasts, this level of simplicity isn’t possible. If you like to make active trades, purchase many different cryptocurrencies, use multiple exchanges, hold your assets in multiple wallets, and explore Defi applications, you’ll need a tool to help you out.
Luckily, multiple crypto tax reporting software companies have emerged. When you use a product like Koinly or TaxBit, you can use link your crypto wallets, via API, to the software.
It can then cross-reference all of your crypto transactions. It will tally everything up, whether it’s dozens of transactions or thousands, and list your total gains or losses.
This number can then be included on your tax return, and you can download and send your report to the IRS for proof.
Typically, you’ll the amount you pay for the software will vary based on the number of transactions you make in a year. So active day traders are likely to pay more since they will have hundreds and hundreds of transactions to analyze.
Cryptocurrency Is Taxed Like Everything Else
Cryptocurrency tax is a huge topic and a complicated one at best. But it’s important to know about the tax implications associated with buying, selling, and using cryptocurrency.
While crypto can be a profitable investment opportunity, it comes at the same cost as any other asset class. If you plan to invest in crypto, or already hold it on your balance sheet, it’s important to use crypto tax software in order to accurately calculate your net gains or losses.
Looking for more tax-saving tips? Take a look at these strategies to minimize tax burdens.