For many, cryptocurrency has emerged as a preferred form of commerce and investment. However, for taxation reasons, the Internal Revenue Service (IRS) views it as property. Any revenue or profit derived from bitcoin investments is thus taxed. In this post, we’ll talk about how and when cryptocurrencies are taxed, as well as the kinds of cryptocurrency taxable and non taxable events.
In a Nutshell
- Since the IRS views cryptocurrencies as property for taxation purposes, using them as payment or exchanging them results in taxable events.
- The following cryptocurrency related activities are taxable: trading cryptocurrencies for fiat money, making purchases with them, exchanging one cryptocurrency for another, and getting mined or forked coins.
- The acquisition of cryptocurrency using fiat currency, donations to tax exempt charities or nonprofits, transfers between wallets, and donations to third parties are all exempt from taxes.
- Depending on how long the asset has been held, taxes must be paid on gains made by selling or exchanging cryptocurrencies at either the short term capital gains tax rate or the long term capital gains tax rate.
- Unless cryptocurrency mining is a part of a corporate enterprise, in which case mining costs may be written off, cryptocurrency miners are subject to ordinary income tax.
- In addition to sales tax, purchasing bitcoin may result in a taxable capital gain or loss at the time of sale.
- You must know the cost basis of the virtual currency you are selling when exchanging it for fiat money in order to determine your cryptocurrency taxable gain or loss.
- Exchanges of cryptocurrencies might result in taxable events, therefore it’s critical to keep track of your transactions and appropriately record them on your tax return.
When are Cryptocurrency Taxed?
Cryptocurrencies themselves are not taxable; you are not expected to pay taxes for holding one. The IRS treats cryptocurrencies as property for tax purposes, which means:
- You pay cryptocurrency tax if you sell or use your cryptocurrency in a transaction. This is because it generates capital gains or losses if its market value has changed.
- If you receive cryptocurrency as payment for business purposes, it is taxed as business income.
How do Cryptocurrency Taxes Work?
Because cryptocurrencies are viewed as assets by the IRS, they trigger tax events when they are used as payment or exchanged. When you make a gain you sell, exchange or use cryptocurrencies that have increased in value you must pay cryptocurrency taxes on that gain.
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For example, if you bought 1 BTC at $6,000 and sold it for $8,000 three months later, you will owe tax on the $2,000 gain at the short term capital gains tax rate. Gains on the sale of assets held for less than one year are taxed at your regular tax rate. For the 2022 tax year, it is between 0% and 37%, depending on your income.
If the same transaction were to take place a year or more after the purchase of the cryptocurrency, you would have to pay taxes on long term capital gains. Depending on your total taxable income, it would be 0%, 15% or 20% for the 2022 tax year.
In this way, cryptotaxes work similarly to taxes on other assets or property. They create taxable events for owners when they are used and profits are made. This makes tax triggering events the most crucial factor in understanding cryptotaxes.
Types of Tax Facts Related to Cryptocurrencies
Taxable Events
Taxable events related to cryptocurrency include:
- Exchange cryptocurrency for government issued currency, called fiat money
- Pay for goods, services or property
- Exchange one cryptocurrency for another cryptocurrency
- Receive mined or forked cryptocurrencies.
Non Taxable Events
According to the Tax Agency, the following facts are not subject to taxation:
- Buy cryptocurrency with fiat money
- Give cryptocurrency to a tax exempt charity or non profit organization
- Make a gift of cryptocurrency to a third party (subject to gift exclusions)
- Transfer cryptocurrency between wallets.
Examples of Cryptocurrency Related Tax Events
Buying with Cryptocurrencies
Making a purchase with your crypto is easier than ever. However, this convenience comes at a price: you’ll pay sales tax and create a taxable capital gain or loss at the time of sale. Here’s how it would work if you bought a candy bar with your crypto:
- You transfer the crypto to the trader through your wallet to his wallet, including sales tax.
- If the value of your crypto is higher than when you bought it, you have created a taxable event with a realized capital gain. If it is less, you have a capital loss. Each must be reported at tax time.
- Because it is a taxable event, you need to record the amount you spent and its fair market value at the time of the transaction.
Therefore, if you use a cryptocurrency whose value has increased, you are taxed twice: sales tax and capital gains tax.
Buy Cryptocurrency
Suppose you bought 1 bitcoin (BTC) for about $3,700 at the beginning of 2019. At the end of February 2022, 1 BTC was worth $38,500. You could have used it to buy a new car.
This transaction has tax implications for both you and the seller.
- The seller must report the transaction as gross income based on the fair market value of bitcoin at the time of the transaction.
- You must report the transaction as capital gain because you have cashed in an investment to buy something. The gain is the difference between the price you paid for the bitcoin and its value at the time of the transaction.
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Cashing the Cryptocurrency
When exchanging cryptocurrency for fiat money, you will need to know the cost basis of the virtual currency you are selling. The cost basis of a cryptocurrency is the total price in fees and cash you paid. When you exchange your cryptocurrency for cash, you subtract the cost basis from the fair market value of the cryptocurrency at the time of the transaction to get the capital gain or loss.
The excess amount is taxable income if you have a gain.
As with other assets, your taxable gains (or losses) in cryptocurrency are recorded as capital gains or losses.
Cryptocurrency Tax on Mining
The rules are different for cryptocurrency miners. Cryptocurrency miners verify cryptocurrency transactions and add them to the blockchain. They are compensated for the work done with cryptocurrency rewards.
Their remuneration is taxed as ordinary income unless the mining is part of a business enterprise. If the cryptocurrency was obtained as part of a business, miners report it as business income and can deduct expenses arising from their mining operations, such as mining hardware and electricity.
Cryptocurrency Exchange & Cryptocurrency Taxes
Exchanging one cryptocurrency for another also exposes you to cryptocurrency taxes. For example, if you buy one cryptocurrency with another, you are essentially using one to buy another. You will have to declare any gain or loss on the exchanged cryptocurrency.
Many exchanges help cryptocurrency traders keep all this information organized by offering free exports of all transaction data. The trader, or his tax advisor, can use this information to determine the cryptocurrency taxes due.
Cryptocurrency Tax Reporting
To be accurate when it comes to filing your taxes, you will need to be somewhat more organized throughout the year than someone who has no investments. For example, you’ll need to make sure that with each cryptocurrency transaction you have a record of the amount you spent and its market value at the time you used it.
Cryptocurrency brokers generally crypto exchanges will be required to issue Forms 1099 to their customers in tax year 2023 for reporting purposes in 2024.
You can do this manually or choose a blockchain solutions platform that can help you track and organize this data. For example, platforms like CoinTracker offer transaction and wallet tracking that allows you to manage your digital assets and ensure you have access to the tax information of your cryptocurrencies.
Capital gains and losses on cryptocurrencies are reported along with other capital gains and losses on IRS Form 8949, Sales and Dispositions of Capital Assets. If you’re unsure about cryptocurrency taxes, it’s best to talk to a certified accountant when trying to report them, at least for the first time.
Wrap Up about Cryptocurrency Taxes
In a nutshell, the IRS views the majority of cryptocurrencies as convertible virtual currencies, which may be exchanged for actual money and are taxable. Since cryptocurrencies are viewed as assets by the IRS, using them as payment or exchanging them results in taxable events. Exchanging cryptocurrencies for fiat money, buying goods and services with them, trading one cryptocurrency for another, and receiving mined or forked coins are all taxable cryptocurrency related events.
The acquisition of cryptocurrencies using fiat currency, the contribution of cryptocurrencies to tax exempt organizations or charities, the gifting of cryptocurrencies to third parties, and the transfer of cryptocurrency between wallets are all considered non taxable events.
Mining cryptocurrencies is subject to taxation as regular income, and exchanging cryptocurrencies puts you in tax liability. If you own or use cryptocurrencies, it’s critical to understand when you will owe taxes so that you aren’t taken by surprise when the IRS comes to collect.
FAQs about Cryptocurrency Taxes
The majority of cryptocurrencies are convertible virtual currencies, according to the Internal Revenue Service (IRS). They can therefore serve as a form of payment, a store of value, a unit of account, and a medium of trade.
You are not required to pay taxes in order to own a cryptocurrency because they are not taxable in and of themselves. Since the IRS views cryptocurrencies as property for taxation purposes, you must pay tax on them when you sell or use them in a transaction. Cryptocurrencies are taxable as commercial income if you receive them in exchange for goods or services.
The IRS views cryptocurrencies as assets, and their use in transactions or exchanges results in tax events. You are required to pay taxes on any gains you make. For instance, you would be required to pay taxes on the $2,000 gain at the short term capital gains tax rate if you purchased 1 BTC for $6,000 and sold it for $8,000 three months later.
The following cryptocurrency related transactions are taxable: trading cryptocurrencies for fiat money, making purchases of goods, services, or real estate, exchanging one cryptocurrency for another, and getting mined or forked coins. The acquisition of cryptocurrencies using fiat currency, the donation of cryptocurrencies to tax exempt organizations or charities, the transfer of cryptocurrencies between wallets, and the donation of cryptocurrencies to a third party (subject to donation exclusions) are all examples of non taxable events.
When you buy something with cryptocurrency, you have to pay sales tax, and when you sell it, you may have a capital gain or loss that is taxable. Your cryptocurrency will have generated a taxable event with a realized capital gain if its value has increased since you first bought it. You have a capital loss if it is smaller. For taxation purposes, each of these needs to be declared.
The amount of tax you must pay on your crypto depends on how much you spend or trade, your income level and tax bracket, and how long you have held the crypto you have used. For example, you’ll owe tax at the usual income tax rate if you’ve owned it for less than a year and capital gains tax if you’ve held it for more than a year.
There are no legal ways to avoid paying taxes on your cryptocurrencies, except not using them. You will eventually pay taxes when you sell it, use it, convert it to fiat money, trade it or exchange it, if your crypto has experienced an increase in value.
You only pay taxes on your cryptocurrency when you make a profit, which is only when you sell, use or exchange it. Holding a cryptocurrency is not a taxable event.
Article sources for Cryptocurrency Taxes
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- Internal Revenue Service | Cryptocurrency Taxes – Frequently Asked Questions on Virtual Currency Transactions
- Congress.gov | Cryptocurrency Taxes – H.R.3684 – Infrastructure Investment and Jobs Act
- CoinTracker | Cryptocurrency Taxes – Crypto & NFT Taxes Done Fast
