Cryptocurrency is a real asset with real tax implications. It is treated as property by the IRS, so any transaction that results in a gain or loss must be reported on your taxes.
Each time you cash out, exchange or trade your cryptocurrency, the value realized is taxable as income at either long-term or short-term capital gains rates. You also may be able to claim certain expenses associated with your crypto.
Taxes on Transactions
As the cryptocurrency market continues to evolve, tax compliance issues are becoming increasingly complex. Practitioners are eager for updated IRS guidance to provide direction and clarity on these new transactions.
Cryptocurrency is typically classified as property for income tax purposes, meaning that when you sell a crypto asset, you must report any realized gain or loss. The amount realized will be the difference between what you paid for your cryptocurrency and what you received when you sold it.
This is true regardless of whether you sell your cryptocurrency directly or on a centralized exchange. However, reporting obligations could induce people to keep their transaction activity away from centralized exchanges and instead engage in peer-to-peer trades that are harder for tax authorities to penetrate. This is a problem that many countries are working to resolve through new blanket regulations and other efforts. Until then, it’s important to carefully consider your cryptocurrency sales to ensure you comply with tax laws.
Taxes on Gains
Global investment in crypto assets has skyrocketed in the past 13 years, boosting market capitalization to more than $3 trillion. While blockchain technology is bypassing conventional intermediaries and accelerating transaction times, it also poses new challenges for tax authorities.
Generally, you must report any capital gains earned through the disposal of cryptocurrency. This includes selling cryptocurrencies, exchanging one cryptocurrency for another, paying for goods or services with crypto and using it to buy property or exchange it for other currencies. Likewise, you must report any capital losses on cryptocurrency investments if you sell them for a loss. Capital losses can offset capital gains and up to $3,000 of ordinary income.
There are many other taxable events related to owning and disposing of cryptocurrency. These include getting paid in crypto, mining cryptocurrency, staking crypto and even spending or swapping your crypto for more than a year that has appreciated in value. In fact, a plethora of activities may trigger a reporting obligation and, if not reported correctly, you could face steep penalties and interest.
Taxes on Distributions
The IRS has been sending letters to crypto investors it believes are underreporting or evading taxes on their investments. Investors must report crypto transactions on Form 1040 if they earn more than $15,000 in income from their crypto investments, receive a hard fork airdrop or give away crypto that is less than $15,000.
The gains or losses on cryptocurrency are taxed the same as with other assets. The profit or loss is determined by subtracting your cost basis — the price you paid to purchase the cryptocurrency — from the sale price or proceeds when you sell it. If you held the crypto for more than a year, your gain is subject to lower capital gains rates.
The wash sale rule prevents taxpayers from avoiding taxes by selling virtual assets at a loss and buying them back shortly after. For this reason, you should never move your crypto between wallets unless it is for investment purposes.
Taxes on Airdrops
The IRS treats cryptocurrencies like property, so when you sell or exchange them for cash, you’re responsible for reporting any profit. Additionally, those who mine Bitcoin or other cryptos are required to pay self-employment taxes.
The tax treatment of airdrops depends on the jurisdiction. Generally, airdropped tokens are treated as income when they’re claimed and must be reported at their fair market value. Moreover, when they’re sold or exchanged later on, they are subject to capital gains taxation (based on the cost basis of the airdropped tokens).
In this volatile market, it’s important for investors to stay abreast of changes in crypto tax regulations. Most regulatory agencies and crypto exchanges provide news bulletins when reporting requirements change or new forms are issued. In addition, media outlets that cover the cryptocurrency world frequently run stories reminding crypto investors about their tax responsibilities. By following these tips, investors can make smarter investments while protecting their assets. This includes using hardware wallets, employing two-factor authentication, and double-checking website URLs to prevent being scammed.