Crypto assets that can be used as currency have become incredibly popular and widespread, yet can present complicated taxation issues. From reporting gains to tracking the costs involved, keeping up with requirements can be challenging.
Anytime you sell or trade crypto for another currency or use it to buy goods or services, a taxable event occurs. The exact amount depends on your tax bracket and whether or not there was short-term or long-term gain realized.
How do I pay taxes on crypto?
Cryptocurrency taxes can be an intricate topic. While cryptocurrency taxes differ slightly depending on which asset or property it’s part of, in general it follows similar regulations as any other asset or property: when selling one coin you trigger capital gains taxes. Trading between coins generates additional gains which must also be reported when trading between cryptos. Non-fungible tokens (NFTs) also fall under this classification.
Airdrops of new tokens in your crypto wallet are another sure way to trigger cryptocurrency taxes, as this occurs when a newly launched cryptocurrency project provides free tokens to early adopters as an incentive for joining and using its platform and community. As this counts as value exchanged for time and effort spent contributing, these events should also be taxed as income events.
Lastly, if you use cryptocurrency to purchase goods and services, this must be reported as taxable income. As with any payment method, cryptocurrency transactions should be treated the same as traditional payments and therefore should be reported as income.
Finally, if you mine cryptocurrency for income purposes, any income earned will need to be reported and taxed according to its value fluctuations and what compensation there might be in cryptocurrency for verifying transactions on the blockchain. Just like when working as an employee.
At its core, reporting all taxable events in a timely fashion – be they gains or losses – will ensure accurate records are kept and penalties can be avoided at tax time.
As well as capital gains taxes, cryptocurrency taxes may apply in other ways as well. These may include transaction fees charged when buying and selling cryptocurrency on exchanges as well as network transaction fees paid to validators who verify your transactions on blockchains.
These cryptocurrency taxes can be costly and leave you owing a considerable sum when filing taxes, yet you may be able to lower it by keeping an accurate record of all of your crypto investment activity and tracking taxable events in one convenient place. Furthermore, any capital losses made can be offset against other sources of income received during the year to significantly lower your overall cryptocurrency tax bill.
How do I know if I owe taxes?
Cryptocurrency transactions are taxed as ordinary income if sold or exchanged for fiat currency or another cryptocurrency, while capital gains if held for more than one year. You’ll also pay taxes on units acquired through airdrops or hard forks if their values increase over time; there is no legal way to evade paying taxes on crypto; the IRS keeps an eye on your transaction activity and may audit you if not reported; penalties include substantial fines and even jail time.
Step one of determining whether you owe taxes on your crypto is to ascertain its cost basis – that is, all money and fees spent when buying it- so as to be able to ascertain any possible profit or losses at sale time. For this, apps like CoinTracker may help.
To calculate your profit, subtract the original cost basis from the sales price or proceeds of any cryptocurrency you sold. Additionally, it’s essential that you know its fair market value at the time of sale so you can file your tax return and calculate how much tax is due or has already been paid on.
If you sell cryptocurrency for a profit, regular income tax rates apply if it has been held less than a year; long-term capital gains rates apply otherwise. To reduce your tax burden and maximize profit on sale, it might be worthwhile considering selling off some older coins prior to selling newer ones.
Utilizing cryptocurrency to purchase goods and services creates a taxable event if its value increases. To calculate this event accurately, it is essential that you know both its fair market value at time of purchase as well as how much was spent in fiat currency on said purchase to determine whether there was any taxable gain or loss.
As opposed to trading stocks, cryptocurrency trading does not follow a wash-sale rule; thus allowing traders to sell and repurchase positions with minimal tax implications. Unfortunately, however, this loophole could potentially be closed by the IRS; hence why it’s imperative that you maintain accurate records of your cryptocurrency trades.
How do I know if I’ve made a taxable event?
Cryptocurrency is considered a capital asset and as with other assets or property that you own, cryptocurrency sales trigger a tax event when they’re sold, traded, exchanged or used as payment. When these transactions produce profits that result in gains they’re subject to short or long-term capital gains taxes depending on how long you held onto them and their original purchase price (known as their “cost basis”).
The Internal Revenue Service defines a cryptocurrency transaction as a taxable event whenever you sell or trade cryptocurrency for cash or use it to pay for goods and services from third-party providers. Furthermore, receiving crypto gifts or donations counts as a taxable event should it then be used to purchase goods and services.
This tax treatment of digital assets differs significantly from that of other digital assets, which typically aren’t subject to taxes unless sold or traded for cash or moved between accounts in which tax is payable. Any taxable events must generally be reported using Form 8949 Capital Gains and Losses when disposing of them on your tax return.
Cashing out cryptocurrency through either centralized or decentralized cryptocurrency exchanges, spending it to buy goods and services with it, or receiving new crypto tokens as part of a hard fork or other blockchain network upgrade is considered a taxable event. Such tokens may be given out for free as incentives to adopt the updated network instead of adopting its predecessor network – these new, free tokens may even encourage users to transition over to it and replace the older network altogether.
Mining cryptocurrency or earning it through other activities constitutes taxable income that must be reported on your 1099-MISC form as ordinary income.
Maintain a log of all crypto transactions and understand which events qualify as taxable events, otherwise penalties could arise due to underpayment of taxes. As it’s best to be truthful when filling out your forms, being honest is key; otherwise the Internal Revenue Service (IRS) could audit those who submit false or inaccurate data and may impose civil and criminal penalties for not filing accurate tax returns. At any rate, it’s always preferable to pay the taxes that you owe than face the consequences of not doing so. Therefore, using an established cryptocurrency tax software provider and maintaining accurate records is highly advised in order to reduce errors or missouts of tax breaks and potentially lower liabilities through tax loss harvesting, prioritizing long-term capital gains over short term gains, selling crypto during years with lower income and prioritizing long term gains over short-term ones.