It’s no secret that cryptocurrency is all the rage.
Cryptocurrency is slowly but surely redefining and helping expand the world of finance, with companies like PayPal and JPMorgan jumping into the fray to support the growth of cryptocurrencies.
In the United States, 59 million people own some form of cryptocurrency. Despite its volatility, crypto remains a favorite of investors seeking a hedge against expansionary monetary policies and impending global economic instability — as well as those seeking massive returns.
In light of the rising popularity of cryptocurrency, tax authorities are slowly developing compliance and reporting regulations. Expect the IRS to take a closer look at your tax returns for any discrepancies involving cryptocurrencies.
Here’s what you need to know about the tax implications of owning and trading crypto.
At a Glance
- Thetax treatment of cryptocurrency is similar to that of other securities, such as stocks and mutual funds.
- Crypto comes with a cost basis. When you sell your crypto, it will either be a taxable gain or loss based on your cost basis.
- If you’re paid in crypto, it’ll be taxed at ordinary income rates.
- You’ll receive better capital gain rates if you holdyour crypto for 12 months or longer.
- You’ll need to pay taxes at the short-term capital gains rate if you choose to sell before the 12-month mark.
What is cryptocurrency?
A cryptocurrency is a decentralized, digital store of value and medium of exchange. It does not have any physical tokens, such as dollar bills, nor does it have any centralized governing authority.
The first cryptocurrency, Bitcoin was launched in 2009. Today there are thousands of others in circulation, including Ethereum, Bitcoin Cash, Litecoin, and Ripple.
Cryptocurrency relies on encrypted, distributed ledgers — known as blockchain technology — that ensures the record and verification of every transaction. Think of blockchain ledgers as a constantly updated checkbook that tracks every single transaction ever made in a given cryptocurrency.
How does cryptocurrency work?
The most important difference is that cryptocurrencies don’t rely on a central authority for their issuance or validation. Instead, crypto-mining operations are responsible for creating new currency. Mining is the process of adding transaction records to Bitcoin’s public ledger (the blockchain).
There are no physical Bitcoins or any other form of digital currency that you can hold in your hand like an actual coin. However, this doesn’t mean it isn’t real money — just ask anyone who bought Bitcoin at its all-time high of over $64,000 per coin in April 2021!
Make sure you’re adequately diversified
Diversifying with cryptocurrency is much different than doing so with traditional securities. We encourage you to speak with a Fiduciary expert before moving forward.
Get in touch to start the conversation today!
Do you have to pay taxes on crypto?
While cryptocurrency is still in its infancy stage compared to traditional currencies like the USD or Euro, many countries around the world have started taxing crypto transactions according to their current tax laws.
So, the short answer is yes — crypto owners are required to pay taxes on capital gains. This means that crypto transactions (buying and selling) will be taxed based on the price of crypto at the time of sale.
For example: If you buy $100,000 worth of Bitcoin in February 2021 and sell your Bitcoin for $10,000 profit in August 2021, then you’ll have to pay taxes on that $10,000.
Not reporting crypto-related income can lead to major fines and, yes, potential jail time depending on how much was earned during such activities.
Crypto miners must also report any earnings from selling mined coins as part of their taxable income unless they hold onto these coins long-term (over 12 months). If you hold onto your coins for at least a year, any crypto-related income will be taxed at a lower rate.
Cryptocurrency activities that constitute a taxable event
Depending on how you got it and how you use it, you may be subject to taxes on cryptocurrency.
Did you mine cryptocurrency?
Crypto mining is the process of using computers to solve complicated equations and record data on the blockchain. You may be compensated in new cryptocurrency tokens for this work. You owe taxes on the entire value of the cryptocurrency you’ve obtained by mining.
Did you get crypto as a reward or an airdrop?
If you receive cryptocurrency through a marketing promotion or an airdrop, it counts as taxable income.
Did you receive payment in crypto form?
If someone pays you crypto in exchange for goods or services, the entire payment counts as taxable income, just as if they paid you in cash. However, unlike with a cash payment, your customer might also owe income taxes if their crypto provides them with greater value than they paid for it.
Did you sell cryptocurrency to realize an investment gain?
If you sell crypto for more than you paid for it, you owe tax on the gain as you would with stocks or mutual funds.
Did you convert or exchange one crypto for another?
When you convert or exchange crypto, you owe taxes on any gains earned in the transaction. If you purchased $500 worth of Ethereum and used it to buy $1,000 worth of Litecoin, you’d owe taxes on $500 in realized profit, even though you’re just exchanging one crypto for another.
The IRS requires you to report these transactions on the 8949 tax form.
Crypto & Tax-Loss Harvesting
The crypto tax code has a nuance that could be the difference between having to pay taxes or being able to delay payment until you sell your crypto.
Because the IRS classifies digital currencies as property, losses on crypto holdings are treated much differently than losses on stocks and mutual funds. As of November 2021, wash sale rules don’t apply, meaning that you can sell your Bitcoin and buy it right back — whereas with a stock, you would have to wait 30 days to buy it back.
By waiting for crypto prices to fall before selling them (and thus creating short-term cryptocurrency loss), crypto owners may be able to defer their crypto taxes indefinitely by continuing this practice year after year!
In addition to gains and losses, you will need to report all receipts of cryptocurrency earned as income on your income tax forms, such as:
- Mining or staking cryptocurrency
- Receipt of airdropped tokens
- Payments received in the form of cryptocurrency
Depending on your crypto transactions, you may have both capital gains and ordinary income cryptocurrency tax events to report.
Tax on cryptocurrency gains
Here’s some good news for crypto investors: You only owe taxes if you spend or sell it and realize a profit. If you sell or spend your crypto at a loss, you don’t owe any taxes on the transaction.
Losses can offset other capital gains in order to reduce overall taxable income but short-term capital losses cannot be carried over into future years — they must be used during that same year’s reporting period.
Reporting crypto losses on taxes
It’s important to keep track of the value of your crypto in order to report it accurately on your tax return.
When you realize losses after trading, selling, or otherwise disposing of your crypto, your losses offset your capital gains and up to $3,000 of personal income.
Any net losses exceeding $3,000 can be rolled forward into future tax years.
When crypto transactions are considered taxable events, you must record the date and time along with its corresponding market price at that moment for all crypto/crypto trades.
How to report crypto on your tax return
In the U.S., you are required to report your cryptocurrency taxes via the IRS Form 8949, Schedule D, and if necessary, the 1040 Schedule 1 and/or 1040 Schedule C.
You will not file a Schedule D if you do not have any realized gains or losses; even if the value changes, if there’s no sale, exchange, or use for products and services there is no taxable event to report.
Step 1: Calculate your crypto taxes
You need to know how much your capital gains or losses are.
Step 2: Create tax form 8949
Once you’ve calculated your crypto taxes, create the tax form for cryptocurrency: the Form 8949.
Step 3: Include on your Form Schedule D
Include your totals from your Form 8949 on your Form Schedule D as indicated on the form.
Step 4: Include crypto income totals
If you have crypto income, include the crypto income totals on the 1040 Schedule 1.
If you are engaging in crypto activities as Self-Employed, use Schedule C instead.
Step 5: File
Complete the rest of your tax return, file, and you’re done.
Keep track of your cryptocurrency activity
While it might seem like there is a lot to track, you’re required to report your crypto transactions on your tax returns. Don’t take any shortcuts in keeping track of our crypto activity.
- Keep records of the fair market value of your crypto when you mined it or bought it, as well as records of its fair market value when you used it or sold it. You’ll use this information to calculate your taxes.
- Understand that that information may not be easily available. If, for example, you were buying and selling stocks, your broker would send you a Form 1099-B that would show the cost basis of your transaction. But with crypto, you might not receive one — one reason why many crypto investors have no idea that they’re liable for taxes.
- A Form 1099-K might be issued if you’re transacting more than $20,000 in payments and 200 transactions a year. Both conditions have to be met. You still owe tax on any gains regardless of whether you cross these thresholds.
We Can Help
Cryptocurrency presents unique challenges, from navigating income tax consequences to investment and distribution by executors and trustees.
Need help figuring out whether cryptocurrency is right from you?
Fill out the form below, or call our San Ramon, CA office at (925) 314-8500 to schedule your free consultation today.