Cryptocurrencies have proliferated quickly since Bitcoin‘s debut in 2009. But their anonymity, rapid evolution, and information gaps present serious difficulties to tax administrators.
Every time you spend or dispose of cryptocurrency – whether through mining, staking or receipt from employers or clients – a taxable event occurs that requires proper record keeping and calculation.
Buying and Holding
Cryptocurrency trading and purchases, as well as receiving them as gifts or compensation from an employer or client, all trigger taxable events. For instance, if you purchase some cryptocurrency that appreciates in value later on, your profit (technically considered capital gains) will be taxed according to long- and short-term capital gains rates depending on how long you held onto it before selling.
Constantly keeping track of both your cost basis and effective realized price is essential when calculating tax bills, making keeping accurate records easier than ever before. Many exchanges offer free exports of all trade data so traders can stay organized and maintain accurate records more easily.
IRS also taxes cryptocurrency when used to purchase goods or services, with increased value measured from when you sold or cashed it in for goods and services. “People tend to forget that using crypto is also a taxable event,” Chandrasekera notes, adding: “Using it even just once could trigger this tax event – even paying with crypto for coffee could qualify!”
Rules regarding cryptocurrency mining operations differ slightly than for ordinary income taxpayers. Cryptocurrency miners verify transactions on the blockchain, and receive rewards that are automatically deposited to their crypto accounts as compensation for their work. Depending on your jurisdiction, any rewards may be taxed as ordinary income; otherwise you may be able to deduct expenses related to mining operations from your taxes.
IRS taxes cryptocurrency when it is exchanged for fiat currency or another cryptocurrency. When selling or exchanging crypto for fiat, they subtract your cost basis from its fair market value at time of sale to determine its taxable amount. “People don’t realize exchanging one crypto for another can be considered taxable activity,” Chandrasekera states, noting that IRS is getting better at tracking such activity to detect tax evasion and money laundering schemes.
Selling and Disposing
Cryptocurrency is considered property by the IRS, meaning any gains and losses on it are subject to tax. Therefore, it’s crucial that you maintain accurate records regarding all cryptocurrency transactions so you can file accurate tax returns when filing taxes.
As with cash income, cryptocurrency received as payment for goods or services is treated as ordinary income in much the same manner. When selling cryptocurrency for profit, however, you will need to subtract your cost basis from its sale price to calculate any capital gain or loss that might be subject to taxes; if held for over one year before selling, your gain or loss may even qualify for lower tax rates than if sold immediately.
When trading cryptocurrency on an exchange, it should be treated like selling any other stock or asset. The IRS requires traders to report any trade they make as they would with any investment; with one exception for transactions wherein an individual trades it solely with the intention of immediately repurchasing it shortly afterwards; due to legislation being considered which could close this loophole later.
Crypto taxes can be particularly complex due to their anonymous trading on decentralized exchanges and peer-to-peer transactions, making it hard for tax administrators to track and verify transaction details, making tax evasion easier. As a result, the IRS has increased enforcement and surveillance against potential crypto tax evasion, including in high-profile cases like FTX’s collapse last year.
As well as reporting gains and losses, you must account accurately when disposing of taxable assets – this includes exchanging cryptocurrency (such as bitcoin for ether) for other currencies or spending it to pay for goods or services. HMRC notes that loss or theft of your private key does not count as a disposal; rather it must demonstrate there is no realistic hope of recovering your lost interest for it to qualify as such a disposal.
Mining and Staking
Cryptocurrency is a relatively recent digital asset that has grown immensely quickly and anonymously, becoming an extremely popular means of payment that has tax systems scrambling to catch up.
The IRS treats cryptocurrency like any property for tax purposes, making its sale or other disposition taxable. When making such transactions with cryptocurrency, its cost basis must be tracked as well as any gain or loss in U.S. dollars as determined by whether your transaction results in profit or loss.
Although purchasing and holding crypto isn’t considered tax deductible, it’s still wise to keep records of your purchases for tax purposes. Should you ever decide to sell your coins, you will need to know their cost basis and fair market value in USD at the time of sale; additionally, capital gains taxes will need to be filed if their value appreciates.
Mining cryptocurrency yourself is subject to ordinary income tax rates (similar to salary), with any proceeds subject to capital gains rates after one year of ownership. Staking, wherein assets are locked for an indeterminate timeframe in exchange for governance tokens and interest payments, is another taxable activity.
Due to cryptocurrency prices being so volatile, traders have the ability to create wash-sale losses through loopholes like wash-sale losses. This practice allows traders to sell a position, book a loss and then quickly repurchase it without being required to declare it as a taxable loss; contributing significantly to market instability while diminishing tax revenue.
While some countries are taking steps to address the problem by creating specific cryptocurrency tax regimes, there’s no avoiding taxation on crypto assets unless you stop using them entirely. As part of their response, centralized exchanges may introduce KYC rules withholding taxes at source – this will reduce incentives for people using unofficial platforms and promote greater compliance.
Payments
People use cryptocurrency in various ways to pay for goods and services. Some municipalities now permit residents to pay utility bills with cryptocurrency; payment processors offer crypto debit cards so people can spend cryptocurrency when shopping; cryptocurrency can also be exchanged for real currency on exchanges while some merchants accept cryptocurrencies as payment.
Those receiving cryptocurrency as payment for goods or services must report its dollar value to the IRS just like when reporting cash income or checks.
When someone sells or disposes of cryptocurrency, they realize a capital gain or loss based on its price at which they sold or bought it. When selling their crypto for cash, they typically are required to report this sale via Form 1099 while this also holds true when selling through exchanges.
Individuals receiving crypto as compensation are taxed at their regular income tax rates due to its classification by the IRS as property transactions that fall under general property rules. Employers paying workers in cryptocurrency follow similar taxation regulations when their payments include crypto. Getting paid with crypto from an employer should be treated like any other form of compensation such as cash or check; mining crypto incurs earnings taxes calculated based on its fair market value at time of acquisition (known as cost basis) while individuals engaging in mining crypto mining as part of a business may owe self-employment taxes when mining cryptocurrency earnings exceed fair market values when acquired when purchasing them; or self-employment taxes due owed.
People who donate or otherwise transfer crypto must report it to the IRS unless using their annual gift exemption or other exclusions. Furthermore, those receiving cryptocurrency through airdrops or hard forks must include its value as part of their ordinary income.
Businesses accepting cryptocurrency should keep in mind that the wash-sale rule doesn’t apply, meaning traders cannot quickly sell and rebuy a position to avoid incurring wash-sale losses. But even though this applies, crypto shouldn’t necessarily be accepted as payment due to its highly variable prices and associated risks.