How to Handle Taxes and Crypto
Neither this post, nor any other on cryptofal.com should be taken as financial advice. It is not.
This post is an excerpt from the January 2022 newsletter.
Cryptocurrency still operates in a regulatory grey area in most jurisdictions. The US is one of these jurisdictions. However, there is one federal agency in the US that has some pretty clear parameters on how cryptocurrency should be handled, and that’s the IRS.
Cryptocurrency gains made in the US are subject to capital gains tax. This means that cryptocurrencies are treated similarly (in the eyes of the IRS) to traditional securities, even though many in the space believe this is an inaccurate tax model for the new asset class. Of course, not all cryptocurrency-based activities are taxable events, so it’s important to have an idea of what’s taxable and what isn’t.
It should be noted that this is not tax advice. For that, you should see a certified tax representative.
To start, what does the IRS consider a taxable event?
According to cryptotrader.tax:
“A taxable event simply refers to a scenario in which you trigger or realize income. As seen in the IRS virtual currency guidance, the following are all considered taxable events for cryptocurrency:
1. Trading crypto to fiat currency like the US dollar
2. Trading one crypto for another cryptocurrency
3. Spending crypto to purchase goods or services
4. Earning crypto as income”
In situations where you sell your cryptocurrency into fiat, the difference between the market value (in USD) you purchased it at, compared to the market value you sold it at is what determines what is taxable as a capital gain. So, if you purchased 1 BTC for $45,000 and sold it for $50,000, that $5k in profit is a taxable capital gain. If it sold for a loss, you can actually report this as a capital loss as well. For example, if the buy price was the same, but the sell price was at $40,000, that capital loss will reduce your taxable income. It should also be noted that the amount of time it is held will influence whether it is a short-term capital gain or a long-term capital gain. Shorter-term trades held for less than are taxed at a higher rate.
It should be noted that the amount of time you held it as well as your tax bracket will affect your actual tax rate for that taxable event.
When you trade cryptocurrency for another cryptocurrency it is also considered a taxable event. It is based on the USD value that you purchased it at and the US dollar value that you traded it into another currency in. So if you purchased $40,000 worth of BTC, and then it grows in value and that is traded for $45,000 worth of ETH, that $5k will be treated as a capital gain. For this type of trade, it’s the same rules as trading into fiat, which means that a capital loss can be recorded as well. This is considered disposal by the IRS. It should also be noted that shorter-term trades will be taxed at a higher rate here as well.
One of the most controversial taxable events is when cryptocurrency is spent. When cryptocurrency is spent, you will still be subject to capital gains tax on any capital gains made from its initial purchase, to when it was spent on something. So if you bought BTC at $4,000 in 2020, and then sold it for $50,000 in 2021, that’s a taxable capital gain of $46,000. Even though it was spent to purchase something, the IRS still considers this a taxable event if the USD value of that BTC increased from its initial purchase. It should be noted that with this example if it was held for at least a year, the tax burden would be less than if it was held for less than a year. While many in the space believe this to be detrimental to the use-case of cryptocurrencies, unfortunately in the eyes of the IRS this would be a taxable event.
Lastly, receiving cryptocurrency as income is another taxable event, however not as capital gains. It’s taxed as income. This is based on your income bracket.
Cryptotrader.tax created a useful breakdown of different types of “income” in the cryptocurrency space.
“The ordinary income you receive from mining, staking, interest accounts, or perhaps crypto you received as payment from a job get reported on different tax forms, depending on the specific situation.
Schedule C - If you earned crypto as a business entity, like receiving payments for a job or running a cryptocurrency mining operation, this is often treated as self-employment income and is reported on Schedule C.
Schedule B - If you earned staking income or interest rewards from lending out your crypto, this income is generally reported on Schedule B.
Schedule 1 - If you earned crypto from airdrops, forks, or other crypto wages and hobby income, this is generally reported on Schedule 1 as other income.”
There are some types of cryptocurrency interactions that are not taxable events. Purchasing cryptocurrency and holding it is not a taxable event. Just like with other assets that are taxed as capital gains, the taxable event will not occur until it is sold.
Another type of non-taxable event that is more specific to the cryptocurrency space is when you send cryptocurrency from one wallet to another. When you send your BTC, ETH, or any other cryptocurrency you will not incur a tax burden.
These are all important things to keep in mind. However when doing your taxes, if you’re an active cryptocurrency investor who has participated in taxable events, we recommend using a tax service such as TaxBit. These services connect to a variety of exchanges and will tell you what you owe and provide you with the document/s you need for reporting cryptocurrencies on your taxes. These services are some of the safest, and most accurate ways of determining what you may owe (if any) in taxes based on your cryptocurrency transactions for the year.