How Do Crypto Taxes Work?




Crypto enthusiasts probably felt more disappointed than surprised when the IRS started focusing attention on collecting cryptocurrency taxes. As with other assets, the federal and some state governments want to collect their share of a taxpayer’s income or profits. Anybody dealing with digital currency should understand how cryptocurrency taxes work to comply with tax rules and maximize their gains.

The government does not look at digital currency as an actual currency. Instead, it considers cryptocurrency a type of property, similar to other financial assets such as stocks and bonds.
As with equities, the IRS will not tax every transaction. For instance:

• As with equities, buying and holding crypto without selling will not generate a taxable event, even if the digital currency appreciates.
• Crypto holders can donate crypto to a 501(c)(3) nonprofit to claim a deduction.
• Cryptocurrency users may receive gifts or transfer digital coins from one account to another without triggering taxes so long as they own both accounts.

The government taxes events that generate realized gains or income. Selling at a profit, mining profits, staking rewards, interest, paying in crypto or accepting crypto as payment would count as income. For instance:

• Buying digital currency for $500 and selling it for $750 would produce a taxable gain of $250.
• Using that same coin to purchase a $600 computer would produce a gain of $100.
• Trading the crypto for $800 worth of another digital coin would generate $300 in taxable gains.

The IRS already asks filers if they have engaged in any crypto transactions. If so, crypto users assume the responsibility of correctly reporting income and gains. In the past, exchanges had not always made it simple for frequent traders to comb through their accounts to find the information they needed to report.

Traders needed to keep good records or pay for apps to gather information.  There are also free tools—such as Taxcaster—which is a helpful tax tool from TurboTax.  The government plans to require crypto exchanges to issue Form 1099-DA by 2024. This form should make filing easier and more accurate. At the same time, the form will ensure that the IRS already knows about each taxpayer’s crypto activity.

Short- vs. Long-Term Capital Gains

The government may consider taxable crypto transactions as either ordinary income or capital gains. Capital gains come from disposing of digital assets for a profit. Income could stem from activities like receiving payments, staking, interest or airdrops.

Crypto investors should pay attention to the difference between long- and short-term capital gains. The IRS taxes crypto held for less than one year as ordinary income. In contrast, crypto held longer than one year gets taxed at a lower rate for long-term capital gains.

The varying treatment of long-term vs. short-term capital gains can significantly affect tax day. For instance, in 2021, an individual earning $100,000 would fall into the 15% tax bracket for long-term capital gains and the 24% bracket for ordinary income. A seller who made $1,000 in profit could save $90 in taxes by waiting to hold their crypto for one year before selling.

As with other financial assets, investors should consider managing taxes as part of an overall strategy to maximize gains. Given a choice, investors might profit more by selling crypto held longer than a year before any they have recently purchased.

Deductions for Cryptocurrency Losses

Few traders profit from every transaction. At least, they can use capital losses to offset capital gains. Some crypto traders strategically harvest losses to minimize tax bills. The IRS allows a maximum loss deduction of $3,000 annually, but excess losses can carry over to future years.

How to Prepare for Cryptocurrency Taxes

In the future, expect the government to require more strict reporting from crypto traders and exchanges. Taxpayers should take responsibility for keeping track of transactions that might trigger taxes or deductions. Using a crypto tax service could be beneficial. Some brokers or third-party services may provide helpful reports and resources, but many traders also prefer to keep spreadsheets.

About the author, Sam Allcock

Sam has industry-leading expertise in online PR, social strategy, e-commerce and news websites.

Leave a Reply

Your email address will not be published. Required fields are marked

{"email":"Email address invalid","url":"Website address invalid","required":"Required field missing"}