No matter whether you’re an investor or trader of cryptocurrency, it is vitally important that you understand how the IRS views crypto taxes. Crypto taxation works similarly to property investments.
Any time you sell, exchange or use crypto that has appreciated in value, taxes will be assessed according to its fair market value at each transaction.
Buying and Selling
Cryptocurrencies are taxed whenever they are sold or traded, or when their owners recognize a gain. This taxation policy mirrors taxes levied against other property and assets like stocks and bonds. Cryptocurrencies also incur value-added taxes when used to pay for goods and services just like cash transactions would; however, due to being anonymous ownership models conducted using public addresses that can be hard to connect back to individuals or firms for taxation purposes.
When someone sells their crypto for cash, they typically become subject to capital gains taxes that depend on their income level and tax bracket. This is because the IRS views cryptocurrencies as property rather than currency; when exchanging one type of crypto for another or using their coins to buy goods and services they become subject to ordinary income tax rates which typically range between 10%-37%.
When purchasing something with cryptocurrency, the trade is subject to taxes based on both its fair market value and the amount needed for purchase. Although people often don’t think of shopping with crypto as being tax-deductible, Hayden notes it can still trigger taxes when used for gaming or gambling activities.
As with investors and traders in traditional financial assets, cryptocurrency investors and traders must keep careful records of their basis (the cost they paid for the cryptocurrency) and transaction fees to calculate any realized gains or losses. Many exchanges provide tools to assist users with keeping this data organized; export it for use with your tax advisor.
Recordkeeping for cryptocurrency taxes can be laborious and time consuming, as traders and investors must keep a detailed log of every trade involving cryptocurrency including details like its cost at transaction time in U.S. dollars as well as date of trade or sale. Many traders use software built into exchange platforms to manage this aspect, although manual recording can also work just as effectively.
Mining
Investors and traders of cryptocurrency must understand the tax ramifications associated with various transactions involving this cryptocurrency asset class, such as buying/selling/mining/using crypto to pay for goods/services/staking etc.
Crypto is classified by the IRS as property, meaning that any gains and losses on sales or use can be subject to capital gains and losses taxes when sold or used in any capacity. This applies both when trading directly between two parties as well as via exchanges or platforms such as Bittrex.
When selling cryptocurrency for cash, its taxable amount can be determined by subtracting your cost basis from its sale price. Your cost basis consists of both what you paid for your crypto as well as any fees or costs incurred during transaction.
When using crypto to purchase goods and services, your taxable gains or losses are calculated based on the difference between its purchase value and market price at time of transaction. For example, if you purchased a sweater for $10,000 using bitcoin that then lost 20% in value after purchase then this loss would count towards your taxable gains or losses as $20,000.
Mining is an activity which verifies transactions on the blockchain and generates cryptocurrency, in exchange for which miners receive cryptocurrency as reward – this amount may be taxed as income unless mining activity is conducted as part of a business enterprise.
As tempting as it may be to purchase or sell crypto assets to avoid taxes, doing so can be risky. Crypto assets are highly unpredictable and major crypto exchanges have closed down; moreover, IRS enforcement efforts are intensifying and can prosecute individuals who fail to report and pay their crypto-related income and taxes on time. As a result, you should always keep meticulous records and report all crypto income or taxes directly to the IRS – while crypto tax rules may seem complicated at first, there are tools that can simplify recordkeeping and calculation processes and experts available through crypto tax service providers can provide expert help with compliance and avoid costly mistakes that cost money in the long run.
Exchanges
Cryptocurrency investors and traders should remember that exchanging one cryptocurrency for another constitutes a taxable event, with any profits realized upon selling subject to long- and short-term capital gains rates similar to stock sales. Furthermore, any transaction fees paid when purchasing digital assets count towards their cost basis; so keeping accurate records is crucial when making purchases of digital assets.
Even if you’re not a trader, cryptocurrency transactions may require tax payments if you receive wages in crypto or use it for spending. When an employer pays you in cryptocurrency wages, their fair market value is subject to Social Security and Medicare taxes as well as FUT Act taxes and federal income tax withholding. When purchasing goods or services with cryptocurrency as payment, exchange transactions count as taxable events with respect to their fair market value at time of sale being included as tax events.
Furthermore, selling cryptocurrency that you’ve owned for more than one year results in lower long-term capital gains rates compared to selling sooner; hence it may be advantageous to hold onto your crypto for an extended period before selling and take advantage of lower taxes.
Though some crypto enthusiasts may believe that blockchain networks’ decentralized nature makes it impossible for regulators to track their activity, the reality is far different. IRS has successfully obtained information on thousands of people who use popular crypto exchanges by issuing subpoenas against these companies. Therefore, some cryptocurrencies’ privacy features can be misleading and encourage people to keep their activity hidden from tax authorities. Furthermore, many centralized exchanges are subject to standard know-your-customer tracking rules and withholding taxes in some countries; yet the OECD continues its work toward developing an international framework for crypto-related information exchange which will help promote tax compliance.
Spending
Cryptocurrency is a digital asset used to buy goods and services or traded speculatively on exchange platforms such as Binance. The value fluctuates, with tax implications when buying, selling or exchanging it.
Your cryptocurrency transactions and their proceeds must be reported to the IRS, whether selling it or using it to purchase goods and services. The IRS views cryptocurrency sales like any other property sale and you owe capital gains taxes if your sale price is greater than what was originally paid for it. This also applies to exchanging one cryptocurrency for another or mining it yourself and reinvesting proceeds back into crypto mining operations.
Your cryptocurrency‘s capital gain or loss depends on its value; your cost basis in it is calculated using its original purchase price plus any applicable fees you paid. Whenever you spend it, this transaction is considered a sale and taxed accordingly on its dollar-equivalent amount – something most don’t think about when using cryptocurrency! Chandrasekera notes: “People may not think of shopping as being tax-deductible events but using cryptocurrency can change that.” Even something as minor as purchasing Starbucks coffee could count.
Note that when making cryptocurrency purchases, merchants must issue receipts with dollar equivalent values at the time of each transaction to provide to the IRS for tax calculation. Fortunately, many exchanges offer software to track cryptocurrency purchases.
Cryptocurrency taxes present another major difficulty due to transactions being pseudonymous – meaning their identities cannot be linked back to any real people involved – which creates the risk of widespread tax fraud and evasion. Luckily, however, the IRS is monitoring cryptocurrency trading closely and has collected information from major exchanges about matching ‘anonymous’ wallets with known individuals.
Taxing cryptocurrency assets remains in its infancy. Given their rapid pace of innovation and difficulty linking trades to people, policymakers will need to come together in order to find an equitable approach for taxing crypto assets.