Taxes may be a difficult subject to grasp no matter your situation, but when your sources of income go beyond a 9-5 full-time job, it can quickly turn into a nightmare.
It also includes cryptocurrencies.
If you’re involved in cryptocurrency in any way, whether it’s trading, mining, or simply holding digital assets, you should make sure you understand the tax implications of your actions.
In short, IRS classified cryptocurrencies as property. As such, it’s taxed just like gold or real estate. This means that any gains or losses from buying, selling, or exchanging cryptocurrencies are subject to capital gains taxes. If you’re not careful, you could wind up owing a lot of money to the IRS.
But don’t you fret – with a bit of research and some professional help, you won’t have to worry about getting in trouble with the IRS, even if you do some extensive mining, buying, selling, and trading with a variety of different cryptocurrencies.
Here are a few things you need to know about crypto and taxes:
Do You Have to Pay Tax on Crypto?
The answer to this question is, unfortunately, yes.
According to crypto tax US rules and IRS guidelines, if you’ve made any money from cryptocurrency in the form of capital gains, then you will be required to pay taxes on those gains. This applies whether you’ve sold crypto for fiat currency (like USD) or exchanged one cryptocurrency for another.
It’s also important to note that you’re only required to pay taxes on capital gains. This means that if you’ve bought crypto and it’s gone down in value, you don’t have to pay any taxes on the loss. However, you still need to report these losses; the good news is that if you do it, you won’t only protect yourself from the problems – it may also benefit you in the future.
Moreover, you may be required to pay taxes on crypto if you bought any goods or services using the coins, and the value of said cryptocurrency was higher during that transaction than it had been at the time they had been purchased.
Cryptocurrencies are also taxed just like any other income if you accept payments in crypto for the goods or services you provide; what’s interesting is that any cryptocurrency you mine also counts as business income.
When you include cryptocurrencies in your tax return, you always calculate their value according to their equivalent at the time of transactions, not the moment of filing the tax return.
We discuss all the instances and intricacies in more detail further below.
Tax on Buying and Selling Crypto – What Are Capital Gains and Losses?
Capital gains are simply profits that you’ve made from selling an asset for more than you paid for it. For example, let’s say you bought 1 BTC for $10,000 and then sold it later for $15,000. In this case, you would have a capital gain of $5,000, which would be subjected to crypto earnings tax – so only the difference is taxable. Exchange fees are not included.
Capital losses are calculated similarly – just the other way around – to determine how much you’ve lost between buying and selling a cryptocurrency. For instance, let’s say you bought 1 BTC for $10,000 and then sold it later for $8,000. Your capital loss, in this case, is $2,000 – the amount you lost.
And how can your losses actually benefit you?
We’ve already mentioned that it might be in your best interest to report your capital losses as well, even though they are not taxed. That’s because losses can be used for offsetting capital gains, even those unrelated to cryptocurrencies, such as stocks. All in all, your crypto capital losses may therefore reduce your overall tax bill.
However, there’s a limit. If your losses exceed your gains (or you have no gains at all, which, sadly, happens), you can only report up to $3,000 losses. However (again), the remainders can be carried over to subsequent years, so nothing is really lost, just delayed.
Tax on Holding Crypto
Cryptocurrencies bought and held as an investment are not subject to capital gains taxes – unless you sell or convert them for fiat currency or other cryptocurrencies. In this case, the gains (or losses) are subject to crypto taxes.
Tax on Trading Crypto
If you’re trading cryptocurrencies, the IRS considers this activity to be taxable. This means that any gains or losses you incur from buying, selling, or exchanging crypto are subject to capital gains taxes, even if you only trade and exchange for another cryptocurrency and don’t convert it to USD.
Tax on Mining Crypto
As we have already mentioned above, mining cryptocurrencies is also taxable. When you mine, you verify crypto transactions, which are later added to the blockchain, and you get compensated with coins. These coins are considered your business income, and, as such, you need to report them.
However, their status also allows you to deduct any expenses related to mining, i.e., hardware, software, internet connection, electricity bills, etc. – anything that’s contributed to your mining operations.
Tax on Purchasing Goods and Services With Crypto
Here things get even more complicated, firstly because when buying with cryptocurrencies, you will often operate with fractions of coins, so more complex calculations will be involved.
Then, as you spend a coin on a car, a bike, or even a cup of coffee, you still need to know what much crypto was worth when you bought it and what its value is now that you make another purchase with it.
But that’s not all.
It only refers to transactions made with coins that you sell for profit. And if your cryptocurrency had decreased in value before you made the transaction, you won’t be able to report it as a loss.
What About the Fees?
Mining, exchanges, protocols, Ethereum gas fees, electricity – most crypto transactions involve direct fees and/or other financial input from your part. Luckily, in many cases, you can add these costs to your asset’s cost basis, which will decrease your capital gains and/or increase your capital losses.
What Is Not Taxable?
Just like there are exceptions for certain sources of income and expenses when it comes to fiat currencies, there are also cases when your crypto won’t be taxed. For example, if you decide to donate your coins to a charity or non-profit organization or make a gift to another person (or receive it), your donation will not be taxed.
Moreover, if you buy crypto with fiat money, it’s considered a purchase by the IRS, and it’s not taxed; it only gets taxable when you sell it, either for fiat currency or another crypto.
It’s worth noting that transferring your cryptocurrency between wallets isn’t treated as a transaction, and thus it’s not taxed – as long as you’re the owner of both wallets.
How to Keep Track of All Taxable Events?
It’s essential to keep track of all your trades so that you can accurately calculate your gains and losses when it comes time to file your taxes. Many exchanges now provide users with a downloadable report of their trading activity, which can make this process a lot easier. Such a document can be later used by a trader, their accountant, or anyone else managing taxes to calculate how much is due.
If you’re using an exchange that doesn’t provide you with such a report, however, there are also other solutions, e.g., blockchain platforms (like TrustVerse) that record and even classify the data to help you get an accurate report.
How Do I Calculate My Crypto Taxes?
As you have probably already noticed by now, calculating your crypto taxes can be a bit tricky. You might get caught up in questions and doubts regarding your actual profits or determining what’s taxable and what’s not. So, let’s go through everything you need to know one by one.
Determine Your Cost Basis
A cost basis is an original price you paid for a cryptocurrency; however, if you mined it, it’s the fair market value at the time you received said crypto asset, and if someone has gifted you with crypto, it will be a combination of the fair market value at the time you received it and the cost basis of the person who has gifted you.
If you sell your crypto, you need to calculate your capital gains or capital losses (see above).
Short-Term Capital Gains and Long-Term Capital Gains
In the US, cryptocurrencies are taxed both at the state and federal levels. As such, the rates may differ. However, what matters is also how long you’ve held your crypto.
At the federal level, you’ll pay less in your taxes for holding cryptocurrencies if you’ve held onto them for more than a year. That’s because such long-term gains are, in general, taxed at a reduced rate – 0%, 15%, or 20%. Your final rate will depend on the total of your income, as the higher-income taxpayers might also qualify for the 3.8% Net Investment Income Tax.
On the other hand, short-term gains are treated just like your regular income, and these rates are usually higher.
Cryptocurrency Tax Accounting Methods
There are several ways to keep track and report your crypto capital gains and losses for tax purposes, and the IRS also allows you to choose the most suitable one.
The most popular specific identification accounting methods include:
- HIFO – highest price assets to be sold first;
- LIFO – assets acquired to be sold last first;
- FIFO – assets acquired first to be sold first.
Calculate Your Crypto Taxes With a Calculator
Sounds complicated? It certainly is. Luckily, there are a few resources that can help:
It is a free crypto tax software that makes all the relevant calculations for you. What’s more, it can help you reduce the amount of taxes you will have to pay the following year. It’s available in 20+ countries and works well with most cryptocurrencies. Its huge advantage is that it doesn’t require any actual records from you. With this software, you can easily import all the transactions from the ledger, sync your trading history and have all the vital information for your tax report within minutes. Koinly does all the calculations; plus, it checks the value of each currency at the moment of the transaction.
It is yet another reliable software with 500+ integrations (all major exchanges, wallets, as well as chains), configurable settings for all types of taxpayers, covering NFTs, DeFi & DEX trading. It considers different tax scenarios and aspects and provides a detailed breakdown of made calculations so that you can get your head around your finances and analyze your situation yourself. All you need to do is import your transactions, and the software will categorize them and calculate the profits, income, and losses. Then, a report is generated for you, and you’re ready to file your tax report. It’s paid, but you can get a free trial to see if it suits your needs.
It is a tool designed to calculate taxes for both crypto and NFTs. However, it goes beyond that. With this software, you can track the coin diversity – view market value, observe your investment performance, or allocation, both in real-time and for tax purposes. It can integrate your history of transactions from a variety of crypto services (it supports 300+ exchanges & 10,000+ cryptocurrencies) and categorize it so that you can browse through it easily. Moreover, it can optimize costs and harvest tax losses, potentially saving you thousands of dollars in the long run. As it’s designed with extensive tax knowledge at its core, it will help you stay fully compliant with the American cryptocurrency tax laws.
It is a crypto taxes platform that you can start using for free. You simply import all your transactions using an app or a desktop version; then, the platform’s special crypto tax calculator gives you the exact numbers regarding your gains and losses; it also displays possible tax-saving opportunities and classifies everything for you to easily analyze your data. Accointing enables you to track your portfolio and even report your taxes by yourself or with the help of either their crypto tax advisors or TurboTax. You also get to browse through valuable insights and analyze your performance and all the transactions so that you’re not in the dark about your cryptocurrencies. What’s more, Accointing allows you to set trackers and alerts as well as review the performance of the cryptocurrencies market. It’s integrated with Twitter, where you can share your opinions and trending tokens with other traders.
Are Crypto Gambling Losses Tax Deductible?
The short answer is yes, but not in all cases, and you also need to meet some requirements.
You can find more detailed information here.
What If I Don’t Include Crypto in My Tax Return?
As stated by the IRS, those who don’t include cryptocurrencies in their tax return or report them incorrectly will face the consequences, e.g., interest, penalties, or even criminal prosecution.
In the past, it was a bit of a gray area, as many governments didn’t know what to do with cryptocurrencies – should they be treated like regular money? However, with time, the US government decided to classify crypto as property. Then, the government officials started to verify tax reports to catch those trying to hide their crypto gains.
Right now, you can even find a question regarding virtual currency on the front page of your tax report. As such, if you don’t include it, you don’t just omit this investment in your tax return, so you can’t defend yourself with ignorance; you’re simply and straightforwardly lying in your tax report, a government document, under penalties of perjury – and that’s not how you want to deal with the IRS.
If you don’t report your crypto gains and losses in your tax return, it might be considered fraud or tax evasion. Moreover, you’re risking not only when you don’t include your current cryptocurrencies. Even though the IRS actually has a three-year lookback for errors, there is no statute of limitations in the case of fraud.
Sadly, you also have to think about whistleblowers. While it might be uncomfortable to think that someone from your close circle would report you, the IRS discloses that the number one way they find out about tax cheats is from an ex-spouse or a former business partner. And it’s not only about who you are in conflict with; such a whistleblower often gets a percentage of the collected penalties.
It sounds surprisingly like a Wild West thing, right?
What Is It Worth Working With a Professional?
Obviously, if you’ve read this far, you know that taxes are no joke and can be confusing to navigate without the help of a professional. Even if you’ve never dealt with taxes before, it’s easy to see that paying taxes on cryptocurrency can be a confusing process.
If you’re just getting into the world of cryptocurrencies, you might not know where to start. This is especially true if you’ve made tons of money on digital currency – you may be tempted to try and file your taxes by yourself.
Don’t do it.
In a world where everything is changing rapidly, and legislation seems to be constantly lagging behind, it’s sometimes hard to figure out what to do – and what not to do.
If you want to be 100% sure that your crypto and taxes are in order, it’s highly recommended you hire a professional accountant who specializes in crypto tax US rules and regulations. A crypto tax specialist will help you file for all the deductions you’re entitled to and make sure that you don’t overpay your taxes. They will also advise you on the best way to procure and store your cryptocurrency.
This will take the guesswork out of everything and ensure that you don’t miss anything.
The Bottom Line
Since crypto is relatively new, there are many gray areas and interpretations around how it should be taxed. However, there’s one certainty: people who don’t pay their crypto taxes will get in trouble with the IRS.
The IRS is looking for cryptocurrency tax evaders, and it’s not hiding this fact. As with all other sources of income, if you don’t report crypto gains, then you will be penalized, and you may have to pay a lot down the line. This is why it’s so important to properly document your crypto transactions and make sure your tax return includes all the relevant information.
When you’re aware of your tax obligations and have done the proper paperwork, filing should be a breeze.
And a specialist can help you further; they will make sure you fulfill all the requirements and provide you with all the necessary information, including forms and tax tools. Knowing that you hired a professional to handle your crypto tax gives you peace of mind. You know that you’re paying the correct taxes, and you don’t have to worry about missing deadlines or to pay unnecessary penalties at a later date.