Disclaimer: This material has been prepared solely for informational purposes and is not intended to provide, and should not be relied upon for, tax, legal, or accounting advice. Before entering into any transaction, you should consult with your own tax, legal, and accounting advisors.
To begin, the following are the most common factors influencing how cryptocurrencies are taxed in the United States:
- How long have you owned the digital asset?
- Your income level
- Is it possible to use tax-loss harvesting?
- 1 Gains in cryptocurrency capital
- 2 Taking advantage of tax breaks
- 3 locating lots
- 4 What if I use my cryptocurrency to make a purchase? Is it still necessary for me to pay taxes?
- 5 Is there a tax break for small crypto purchases in the United States?
- 6 What if I’m paid in cryptocurrency? What kind of taxation will I face?
- 7 Does exchanging one cryptocurrency for another count as a taxable event?
- 8 What is the tax treatment of cryptocurrency airdrops in the United States?
- 9 What is the tax treatment of cryptocurrency forks in the United States?
- 10 What is the tax treatment of cryptocurrency staking in the United States?
- 11 Is there software that can assist with crypto tax reporting?
Gains in cryptocurrency capital
To begin with, you won’t generally have a ‘taxable event’ until you sell (or exchange your crypto for a good or service). We say generally because if you earn interest on your cryptocurrency holdings, that interest is taxable as ‘ordinary’ income.
Let’s take a look at a simple capital gains example. Assume you paid $10,000 for one Bitcoin on January 1st and sold it for $15,000 six months later on June 1st. Your cost basis is $10,000 in this case, and your gain is $5,000. Your gain is the amount on which you must pay taxes. It’s not too difficult.
But how much tax must you pay? This will be determined by:
- Your total capital gains for the entire tax year (including non-crypto trading gains) – the more you made, the higher your tax rate.
- Your financial situation. If you have a higher income, you will pay a higher tax rate on your capital gains. Visit the Internal Revenue Service (IRS) website at www.irs.com for more information on current tax brackets.
- How long did you keep the investment? If you held for less than a year, the gains are added to your ‘ordinary’ income, which means you’ll be taxed at a higher rate. If you held the asset for more than a year, profits are counted as ‘capital gains,’ which are taxed at a lower rate in most cases.
Taking advantage of tax breaks
Tax-loss harvesting is the practice of selling investments at a loss to reduce your tax liability. Assume you bought one bitcoin for $10,000 and sold it for $15,000 the same year. You’d have a $5,000 capital gain, which would be taxable. Let’s say you also bought $10,000 worth of Tesla stock in the same year, and the price plummets. You make the strategic decision to sell your Tesla, incurring a $5,000 loss. This loss can be used to offset your bitcoin gains, effectively eliminating your tax liability. After that, you must wait 30 days from the date you sold your Telsa shares before reinvesting. Fortunately, the price hasn’t recovered, so you’ve effectively avoided any tax liability on your Bitcoin gains while maintaining your Tesla position.
Because the IRS classifies cryptoassets as property, the ‘wash sale’ rule may not apply. This would eliminate the need to wait 30 days after recognizing a loss before reinvesting in cryptocurrency. However, because the IRS has not specifically stated whether the rule applies to crypto – indeed, some cryptoassets are being treated as securities rather than property – many traders are playing it safe by waiting 30 days before buying back in.
The good news is that because you can harvest an unlimited number of losses and carry them forward into an unlimited number of tax years, you should have plenty of opportunities to use this tax strategy.
Assume you buy one bitcoin for $10,000 and another for $20,000. You later sell one coin for $15,000. Did you make a profit or a loss on your investment? The answer is that it is entirely up to you.
Option 1: ‘First come, first served.’ You would have made a $5,000 capital gain in this case.
‘Specific identification,’ option 2. You choose which coins to sell at the time of each transaction. You’ll need to keep meticulous records with this method, but you’ll have more flexibility to reduce your tax burden, including the ability to use a tax-loss harvesting strategy.
What if I use my cryptocurrency to make a purchase? Is it still necessary for me to pay taxes?
Converting cryptocurrency to goods or services is treated the same as trading it on an exchange. This means that the rules outlined above apply. Consider the following example:
Image On January 1st, you paid $10,000 for 1 BTC. Bitcoin’s price had doubled to $20,000 by June 1st. You decide to spend your newfound wealth to buy a $20,000 car with your 1 BTC. What you may not realize is that when you send your BTC to the seller to pay for the car, you are making a $10,000 profit. This is a taxable event, which means you must include it in your tax return.
Is there a tax break for small crypto purchases in the United States?
There are no exceptions. Legislators have twice failed to pass legislation providing an exemption for small purchases. The Virtual Currency Tax Fairness Act of 2020, a more recent bill, proposed an exemption for sales of less than $200. The bill, which was introduced in early 2020, was declared dead in December 2020.
What if I’m paid in cryptocurrency? What kind of taxation will I face?
The same rules apply to price appreciation and depreciation as described above. This means that if you receive cryptocurrency in exchange for goods or services on January 1st, the cryptocurrency’s price on that date is considered your cost basis. If you sell the cryptocurrency or use it to purchase something, your profit or loss will be determined by the price at the time of exchange (minus fees).
Of course, receiving payment in cryptocurrency is subject to income tax in the same way that receiving payment in dollars is. This means that if you immediately convert your cryptocurrency into USD after receiving it, your tax bill will be the same as if you had received dollars.
Does exchanging one cryptocurrency for another count as a taxable event?
Yes. The so-called ‘like-kind’ rule does not apply to cryptocurrency trading in the same way that it does to real estate swapping. In other words, when you exchange one cryptocurrency for another, it is a taxable event, which means you must determine your cost basis and report capital gains.
What is the tax treatment of cryptocurrency airdrops in the United States?
If you receive a token in one of your wallets, whether you requested it or not, you must report the value of that token as ordinary income. Your cost basis is calculated at the time the token was airdropped to you. For example, if you received 400 UNI tokens at 11 a.m. on September 17, 2020, when the price was $0.40/UNI, your cost basis would be $160. If you sold it two days later for $6/UNI, you’d have a $2240 capital gain.
What is the tax treatment of cryptocurrency forks in the United States?
Forks, like airdrops, are classified as ordinary income. Your cost basis is calculated at the time the fork occurs.
What is the tax treatment of cryptocurrency staking in the United States?
Tokens earned through staking are treated as ordinary income, just like interest on bank deposits.
Is there software that can assist with crypto tax reporting?
Because cryptocurrencies are both an investment vehicle and a medium of exchange, properly reporting your taxes can be a time-consuming task. Furthermore, tax laws are changing at a rapid pace. Fortunately, a growing number of tools are available to assist you in complying. We recommend TokenTax, a cryptocurrency tax software platform and cryptocurrency tax calculator that greatly simplifies the process. It assists you in connecting to exchanges, tracking your trades, generating the necessary forms, and automatically compiling your tax report. You’ll want to use capable software to ensure you minimize your tax burden, especially if you plan to implement strategies like tax-loss harvesting.