How is Cryptocurrency Taxed?


Table of Contents

  1. How Is Cryptocurrency Taxed?
  2. Tax on cryptocurrency
  3. How to pay tax on crypto
  4. How to report crypto taxes: calculate your taxes with ease.
  5. How much is crypto taxed: An example
  6. What happens in the case of a capital loss?

Is there a cryptocurrency tax? Understand how the IRS taxes cryptocurrency investments and what constitutes a taxable event if you've invested in cryptocurrency.

How Is Cryptocurrency Taxed?

Are you wondering how crypto tax works and what the IRS rules on crypto tax are? Then, this guide is for you!

Virtual currencies like cryptocurrencies and tokens generated by private companies have grown in popularity over the last several years. The majority of virtual currency users and the authorities of several nations have become particularly interested in cryptocurrencies.

Even though cryptocurrency was initially built to provide decentralisation and an autonomous economy, the government has exerted increasing significant control over the years. You must complete KYC (Know Your Customer) confirmation before you have full access to major crypto exchange services; this defeats the anonymity and autonomy of cryptocurrencies. The government uses the KYC process and users' banking information obtained from crypto exchanges to track crypto transactions. The IRS analyses these transaction records and uses them as tax information; this is in full force in some countries, particularly the US, Canada, India, and Switzerland.

In the United States, the IRS classifies cryptocurrency as property and crypto income and transactions are taxable just like any other property. Government involvement implies that crypto gains or losses are taxable income, and crypto users must pay crypto tax. 

Tax on cryptocurrency

There are two types of taxable events in crypto:

  • Ordinary income: Mining, staking, lending, and compensation for goods and services are considered ordinary income.
  • Capital gains: cryptocurrency sales and exchanges are considered capital gains.

Long-term capital gains (> 1 Year) tax rates are generally 0%, 15%, or 20%. In contrast, the ordinary Income and Short-term capital (> 1 year) gain tax rates are 10-37%.

Non-taxable crypto events include:

  • Buying crypto with fiat currencies
  • Transferring crypto between your wallets
  • Gifting crypto up to a maximum of $15,000 per year to a recipient
  • Crypto donation to charity
  • Crypto Hodling in wallets

How to pay tax on crypto

 When you buy a crypto asset, the cost basis of the asset is the original purchase price of the asset. When you sell that asset, you will be subject to taxation depending on the difference between the price at which it was purchased and the price at which it was sold. This is a taxable event, and the tax return depends on your profit or loss upon selling the asset, calculated as capital gain and capital loss, respectively, by the IRS. There are two types of capital gains: 

  1. Short-term capital gains: Short-term gains Tax rate applies to cryptocurrency holding periods of less than a year. This short-term and ordinary income tax rate in the US is generally between 10-37%.
  2. Long-term Capital gains: Long-term capital gains apply to the crypto holding period of more than a year. In the US, this tax rate is generally 0%,15% or 20%.

As you can see, the Long-term capital gains tax rate is lower than that of ordinary income and the short-term capital gains tax rate. The longer you hold your cryptocurrency, the more profit you make and the less tax you pay. That's some financial advice in disguise!

How to report crypto taxes: calculate your taxes with ease.

Calculating capital gains or losses is easy if you follow the steps we will discuss briefly.

  1. Get your cost basis-Your cost basis is the acquisition price of your crypto asset, including the transaction fees. If you got the crypto for free, like if it was a gift or an airdrop, you'd use the fair market value of that coin asset in USD on the day you got it as the cost basis.

  1. Calculate your capital gain- Subtract your cost basis from your selling price to calculate if you have a capital gain or loss. If the selling price exceeds the cost basis, you will incur a capital gain tax. If otherwise, you will have a capital loss.

  1. Calculate your tax returns: Tax returns depend on several factors, such as your capital gains or losses, the period of holding the asset, and the method you employ for filling out tax returns.

How much is crypto taxed: An example

You buy 1 ETH in April 2021, valued at $1900, and pay a 1.5% transaction fee. Your cost basis is $1900. 

In November 2021, you sold 1 ETH for $4800: This is a taxable event. To calculate your capital gain or loss, subtract the selling price from your cost basis.

$4800 - $1900 = $2900

You’ve made a capital gain of $2900 that is subject to a capital gains tax payment to the IRS. Since you held your ETH for less than a year, which type of Capital Gains Tax rate will you pay based on your regular Income Tax rate? You are absolutely correct if your Short-term Capital Gains Tax rate comes to mind. 

 In the US, a $2900 short-term capital gain will attract a 10% tax rate, so you'll pay 10% of $2900- a total of $290. Sounds easy!

That was a simple example; what if we are dealing with multiple assets? 

In this case, the IRS applies the first-in, first-out method as a default to calculate capital gain or loss. However, taxpayers can select other options that employ precise transaction ID matching, such as last-in, first-out (LIFO) or highest-in, first-out (HIFO). HIFO particularly has tax reduction advantages, but it requires meticulous transaction matching, which makes the whole process quite complex. 

When you file your taxes, the percentage of tax that applies to each portion of your profit or income is incrementally increased.

You may need to consult with a tax expert to help you file your taxes.

What happens in the case of a capital loss?

Suppose you incur a capital loss when the value of your cryptocurrency holdings declines, and you decide to sell them at a loss. In that case, you can apply this loss to offset any capital gains you may have, or you can offset up to $3,000 against your ordinary income.

If you cannot use these losses in the current tax year, you can carry them forward into another year. This enables you to apply them effectively to offset future capital gains or income.

Bottom line

Understanding the tax implications of cryptocurrency is essential for anyone involved in this dynamic market. The evolving regulatory landscape, classification of taxable events, and varying tax rates based on holding periods underscore the need for careful consideration and seeking expert guidance to navigate the complexities of cryptocurrency taxation effectively.

Further Reading:

CNBC Crypto tax guide

Coinbase crypto tax guide

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