Cryptocurrency and blockchain technology are transforming the world of finance. More than 21 million U.S. adults own assets like bitcoin or ethereum, crypto credit cards are growing in popularity, and artists are making thousands of dollars selling non-fungible tokens (NFTs).
These products and positions all raise tax implications that too often go unconsidered. Purchasing an NFT with bitcoin? Taxable. Trading your dogecoin for ethereum? Taxable. Using your staking income to buy a coffee from a vendor accepting crypto? Taxable.
Seth Wilks is the Director of Tax & Accounting SME at TaxBit.
You get the idea. Taxes around cryptocurrency can be complicated. Whether you’ve just started dabbling in the world of crypto or you’re a long-time believer, it’s important to understand how cryptocurrency tax reporting works so that you can stay compliant and enable this transformative innovation to continue to thrive.
1. Most crypto activity is taxed as property – and you need to report more than just cashing out
There’s a common misconception that you have to report crypto taxes only when you sell your crypto for fiat currency. While that is indeed a taxable event, it’s not the only activity that you need to include on your return.
For most people who invest and trade cryptocurrency, it’s taxed as property much like stocks. That means you’ll have to report capital gains or losses on Form 8949 for the following activities:
- Selling your crypto for cash
- Trading one cryptocurrency for another cryptocurrency
- Using cryptocurrency at a merchant as payment (for those who use crypto debit cards, this applies to you as well)
- Buying an NFT with crypto.
2. Crypto earned as income also needs to be reported on your tax return
It’s also possible to have received cryptocurrency as income. These interactions will need to be reported on a separate part of your return:
3. If you don’t report your crypto taxes, you run the risk of being audited by the IRS
Failure to report any of the taxable events will likely result in an Internal Revenue Service audit. For the first time this year, the IRS has placed a question at the top of Form 1040 that asks “[a]t any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
So, if you’ve done any of the above taxable crypto activities, it’s in your best interest to answer that question honestly and report your taxes on the proper forms. It should be noted that more and more exchanges are starting to report crypto activities to the IRS through From 1099-B, which means the IRS is already aware of some of your activities.
4. Not all crypto activity is taxable
Good news! Just because you own crypto doesn’t mean you owe taxes. If you bought crypto and haven’t disposed of it, you have no taxable activity to report. Nontaxable activities include:
- Transferring assets between exchanges
- Buying cryptocurrency (although nontaxable, it does set your cost-basis)
- Gifting cryptocurrency (this excludes large gifts that may trigger other tax obligations)
- Donating cryptocurrency (instead, this is tax deductible!).
While donating cryptocurrency is not a taxable event, it is recommended that you do report the donations on your tax return because you may be eligible for the itemized charitable deduction.
5. Wash sale rules don’t apply to crypto
Cryptocurrency provides the unique opportunity of being able to appreciate wealth over time while saving money on taxes. Because wash sale rules don’t apply to cryptocurrency, you can enjoy the tax advantages of offsetting taxable gains with investment losses and immediately buy back the same asset to maintain your position in the asset (i.e. continue to hodl).
6. Crypto tax rates depend on your holding period
The rate cryptocurrency is taxed at depends on how long you held the asset for and your annual income. If you held the asset for less than one year, your cryptocurrency gains will be taxed as a short-term capital gain at the same rate as your ordinary income, with a range of 10% – 37%. If you held the asset for more than one year, it will be taxed at the long-term capital gains tax rate, with a range of 0% – 20%.
7. Capital losses can be used to minimize your tax liability
That’s right! While a bummer at the time, capital losses can be used to offset your gains and reduce the amount of taxes you could owe! Savvy crypto investors are well aware of the tax implications of their trades throughout the year – and they use that to their advantage through a strategy called tax-loss harvesting.
And, even if you don’t have capital gains to offset, tax-loss harvesting could still be beneficial as a capital loss deduction from your income.
Time to file those crypto taxes? Follow these steps:
Step 1: To start, you’ll need a list of all your exchanges and transactions, including any 1099 forms received from exchanges.
Step 2: Next, calculate your capital gains and losses by subtracting your cost-basis, or the price you bought the asset at, from the price you sold the asset at (Capital Gain or Loss = Selling Price – Cost-Basis).
Step 3: Fill out your capital gains and losses on IRS Form 8949 for all events taxable as property.
Step 4: Transfer totals from your IRS 8949 to Form 1040 Schedule D.
Step 5: Fill out any remaining cryptocurrency income on Form 1040 (remember, this is from mining or staking, air drops, or getting paid in crypto).
That’s it! At least for most people. If you are a higher volume trader, the process gets much more complex and it’s recommended that you use crypto tax automation software to calculate your gains and losses.
Keep in mind that the more attention you pay to the tax implications of your crypto transactions year round, the easier you’ll have it come tax time. Not only that, but by making strategic trades in loss positions, you can reduce your tax liability – or even get a tax refund! Your future self will thank you later.