Since the introduction of Bitcoin to the world in 2009, cryptocurrencies have exploded in popularity. This has led to many people becoming interested in investing in cryptocurrencies, as well as using them as a medium of exchange. However, with this increased interest comes increased scrutiny, and one area in which cryptocurrencies are coming under greater focus is taxation.
President Biden’s recent executive order on crypto is encouraging. Instead of pushing specific crypto laws, the order tasks the Department of Homeland Security, the Treasury Department, and the attorneys general of each state with studying the issue and drafting new regulations for crypto.
While the executive order isn’t what most of us wanted to hear (no mention of how to reduce crypto taxes), it is a step in the right direction. As we wait for those new regulations, here are five things you need to know about crypto and taxes right now to stay ahead of the game.
Cryptocurrencies are Property
The current regulations from the Internal Revenue Service (IRS) classify cryptocurrencies as property, instead of a security or currency.
What this means for taxpayers is that crypto assets are subject to capital gains tax—just like stocks, bonds, and other forms of investment. If you bought crypto and then sold it at a profit, you will need to pay capital gains tax on the sale. For instance, if you purchased $20,000 worth of Ethereum (ETH) and sold it later at $40,000, you will have to report and pay taxes on the $20,000 profit.
The same rule applies if you purchase ETH worth $20,000 and use it to purchase more than that amount later. Say your ETH jumps to $40,000 after a few months and you buy a $40,000 car. That means you have $20,000 in taxable gains.
How much you pay depends on your income bracket as well as the duration you held your crypto before selling. If you owned your crypto for one year or less, you have to pay only the short-term capital gains taxes.
For crypto owned longer than a year, long-term capital gains taxes apply. The final rate will vary based on your income. We generally advocate holding crypto for more than a year to take advantage of the lower tax rate for short-term capital gains.
If you received crypto as a gift or inheritance, you won’t have to pay any taxes, except if you sell it to someone else. Until then, you can keep answering “no” to the Form 1040 question.
Charitable Giving is Not a Sale
The IRS does not view the donation of crypto as a sale. However, the deductions you can make as a result of this donation vary depending on how long you have had the currency.
If you have had it for more than a year, the deduction is equal to the fair market value of the currency at the time of donation. If you have had it for less than a year, the deduction is based on the lower between these two values: when you purchased the crypto, or when you donated it.
Cryptocurrencies Received as Payment are Taxable
Crypto as income is taxable, whether you earn crypto from personal clients or your employer. If you receive crypto as a payment for goods or services, they will be taxed as regular income. The value of your coins will be defined as their market values when you received them.
One positive implication of this regulation is that deductions are available for expenses related to earning crypto income. These deductions can include costs like electricity, computer parts, and internet service—we suggest getting in touch with a tax professional to learn about all the possible deductions for which you may be eligible.
Never Lose Track of Your Cost Basis
Because the IRS views the value of a cryptocurrency as its market value the moment you received it in your wallet, keeping immaculate records is key to calculating your tax liability. Anytime you sell, trade, or use your cryptocurrency you’ll need to know its cost basis. Your cost basis is the price at which you purchased the cryptocurrency and any subsequent fees or commissions included in that purchase price.
Make sure your chosen wallet offers features to keep track of your cost basis as well as the date and amount of each transaction. Failing to do so could result in an inaccurate tax bill and potential penalties from the IRS if you’re caught.
Keep All Records
On that note, the IRS is quite clear on your responsibility to prove your claims in an audit. An IRS audit can be a slow and painful experience so it’s important to have all your ducks in a row. Recording all your crypto activity—including sales, receipts, and exchanges—will help you do just that.
If you can’t make heads or tails of the IRS’ crypto policies, talk to an accountant or tax professional, preferably someone with extensive crypto knowledge. They will be able to help you stay consistent and minimize your chances of an IRS audit.
As long as all your records are in order, they should have no problem finding ways to keep your tax bill manageable.
Despite the uncertainty regarding crypto tax regulations, there is enough to work with to lessen your tax burden now. Being aware of the implications of crypto payments and donations as well as keeping meticulous records will go a long way in minimizing headaches come tax season. The IRS has been clear that they view crypto as property, so by following these simple tips you can be sure to stay on their good side.
If you’re just started to get into crypto, we strongly suggest reading up more on the subject. Though we focus primarily on Bitcoin, our
beginner’s guide should cover all the basics of crypto. You can also check out our more in-depth articles about specific aspects of the crypto world as you become more comfortable.
