The IRS considers cryptocurrencies to be property, taxing them similarly to real estate and stocks. But cryptocurrency tax rules can be complicated.
At its core, cryptocurrency tracking requires keeping an accurate record of your cost basis (purchase price plus fees) compared with its value when selling or exchanging assets, in order to recognize any profits subject to ordinary income taxes and capital gains taxes.
Gains
The IRS treats cryptocurrency gains and losses like any other capital gain or loss. If you sell cryptocurrency for more than you originally bought it for, any profits are taxed at its current fair market value as income and should always consult with a qualified tax professional for guidance and advice.
There are certain circumstances where cryptocurrency owners must pay taxes, including buying it with fiat currency or another government-backed currency, exchanging it, mining coins, receiving airdrops and initial coin offerings; however, gifting it to friends and family does not incur tax. Cryptos taxes are calculated based on their fair market value as determined by individual coins or tokens.
when exchanging cryptocurrency for goods, services or real currency. This is because when exchanging cryptocurrency for tangible goods or services you incur a tax liability because the value you receive in return depends on its fair market value on the day and time you completed the exchange – this calculation takes into account your cost basis (how much you paid to acquire the cryptocurrency) when estimating this figure.
One common situation when cryptocurrency taxes may become due is when receiving rewards from staking, as their fair market value must be reported as income. Your type and duration of staking could have an effect on how your staking rewards are taxed accordingly.
When selling or disposing of cryptocurrency, whether for profit or loss, the transaction constitutes a capital transaction and must be reported on your tax return. Any earnings will be subject to both ordinary income tax rates as well as capital gains tax rates depending on how long it was held before selling off.
Maintaining accurate records of your cryptocurrency transactions and cost basis is essential in order to file taxes by April 15th if needed; using blockchain tax reporting software like Blockpit can assist with this task and ensure you remain compliant with law.
Losses
If you have invested in cryptocurrency and sold it at a loss, you must report this as taxable income to the IRS. They treat these losses like other capital losses and apply a tax rate up to 37% depending on your income level and filing status; losses can be offset against gains to lower overall tax liability.
As with stocks and mutual funds, any cryptocurrency purchases that appreciate in value and are later sold at a profit are also taxable gains. While traditional assets like stocks are taxed at ordinary income rates, cryptocurrency transactions tend to be taxed as capital gains at marginal rates of up to 37%.
When purchasing goods and services with cryptocurrency, this counts as a taxable event; its fair market value must be reported along with your cost basis in the crypto used to make the purchase.
An exchange or sale between different cryptocurrencies is another form of tax-liable crypto event. For instance, trading Litecoin for Ethereum would constitute both a sale and taxable event – the fair market valuation of the Ethereum received should be reported as your gain while that given up should be counted as your loss.
Cryptocurrency mining is also considered a taxable activity, since this involves verifying transaction records on the blockchain in return for rewards of cryptocurrency. Miners’ rewards in cryptocurrency may be taxed as ordinary income unless their mining operation qualifies as an independent business enterprise in which case it is taxed as business income and eligible deductions can be claimed against its expenses.
There are various other crypto transactions that qualify as taxable events. Cashing out cryptocurrency for USD or another government currency (such as exchanging one coin for another; such as trading ETH for ADA). Furthermore, using cryptocurrency as payment for goods and services or even exchanging crypto for fiat are all taxable events since the IRS views crypto as property that will be taxed at capital gains rates when sold or converted.
Transactions
Cryptocurrency is taxed in much the same way as other capital assets, like stocks or bonds. Taxes must be reported when selling coins for other currencies or goods and services – this transaction must include both amounts in USD as well as values exchanged, known as realized gains and cost basis (purchase price plus fees and mining costs).
The IRS considers any transaction where your returns exceed what was initially invested as a taxable event, such as receiving payment for goods or services in cryptocurrency via airdrops of NFTs and utility tokens or accepting it as salary or bonus payments. Furthermore, according to IRS rulings you are also required to pay taxes when receiving free crypto as part of an incentive or reward program – such as winning a bitcoin giveaway or $5 for referring friends to an exchange platform.
Hold your cryptocurrency for more than one year and it will be classified as long-term investment property and taxed at a higher rate, similar to how stock or bond investors pay taxes. However, if you sell it within 12 months, ordinary income tax rates apply.
Some individuals use cryptocurrency to conceal illegal activities or launder money, which the IRS is aware of and monitoring closely for signs of fraudulent behavior. Though crypto transactions are decentralized and anonymous, tools exist for tracking them such as using blockchain records of exchanges that must report directly to it as well as having an FBI unit monitor cryptocurrency activity and report back if needed. Furthermore, using it illicitly could result in fines and imprisonment penalties; so the law must constantly change to accommodate newer technologies.
Exchanges
Cryptocurrencies have quickly become an integral component of global financial systems and payment for goods and services of all sorts, but their growing use poses unique taxation challenges. As cryptocurrency ownership proliferated rapidly over the past few years, IRS and government authorities were challenged with creating consistent rules for taxing these assets; one key question being whether they should be treated as property for capital gains tax purposes or currencies for sales/value-added tax (VAT) purposes.
Virtual coins are considered property by the IRS, so any time you sell them for a profit you must report it as part of your annual taxes. Your profit equals the difference between what you paid and its fair market value at time of sale. Using cryptocurrency to purchase goods and services counts as another taxable event where its fair market value at transaction time equals value received as goods/services received as per transaction value of crypto received at time of exchange.
When selling cryptocurrency, the IRS requires you to have a clear idea of your cost basis–the total amount paid for virtual coins plus any fees–in order to assess whether any profits or losses should be reported as income tax. When exchanging it for fiat money, however, subtract your cost basis from its fair market value in order to calculate any capital gains or losses.
Mining cryptocurrency can be taxed like any other wages: your employer is required to withhold federal income tax, Social Security tax, Medicare tax and Federal Unemployment Tax Act tax from your crypto earnings.
Though cryptocurrency exchange reporting does not meet the high standards set for more conventional investments such as stocks, authorities are increasing their enforcement of crypto tax laws. For example, the IRS recently requested a budget increase to better enforce crypto laws. Therefore it is crucial that traders keep a thorough record of their trading activities throughout the year; many exchanges offer free exports of trading data which can help individuals or their tax professionals calculate taxes due.