Over the past decade, cryptocurrency has slowly but surely become one of the hottest investments on the market. While many people were initially skeptical of crypto’s staying power and appeal, the rise of cryptos like Bitcoin has caught the attention of an increasing number of investors. But the IRS is also homing in on crypto taxes—and it’s important that investors know the basics regarding how to file and how to pay taxes on cryptocurrency.
Unfortunately, the IRS doesn’t exactly make it easy to understand how to calculate crypto investors’ tax liability, so a lot of the responsibility to get it right lands on the individual investor.
Of the 6 things to know before investing in crypto, the fact that crypto is taxed is right up there on the list. Read on to learn all you need to know about crypto taxes, including how to file and pay taxes on cryptocurrency.
Related: Guide to taxes and cryptocurrency
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How Do Cryptocurrency Taxes Work
There are many rules and regulations governing crypto, but the most basic thing to understand is that crypto investors are required to report their holdings and gains to the IRS when they file their taxes.
The IRS views cryptocurrencies (which it refers to as “virtual currencies”) as property. Not currency. And because of that, Uncle Sam wants to know what you’re holding, and many crypto holders will have tax liabilities . PDF Fileassociated with their holdings.
As they would with any other property they might own, crypto holders who purchased crypto like a stock or other asset will need to keep track of their crypto transactions. They’ll also need to report the value of their holdings (in U.S. dollars) on their tax filings.
One caveat: cryptocurrency received as a gift or a transaction, or that is mined, is instead treated as income by the IRS, and taxed accordingly.
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Calculating Crypto Taxes
In many ways, investing in cryptocurrencies like Bitcoin is similar to investing in other assets, like stocks or bonds. Likewise, taxes are determined in similar ways.
For instance, when an investor buys and later sells a stock, they have a tax liability on their realized gains. They made money, or income, from the sale, and now owe taxes against that income. It’s a similar situation when it comes to tax on cryptocurrency.
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Crypto Tax Liabilities
Here are some situations in which crypto investors will generate a tax liability on their holdings:
- Cryptocurrency is sold for cash: If you made a profit, that’s a capital gain. Depending on how long you held the crypto before selling, it would either be a short-term or long-term capital gain.
- Cryptocurrency is used to purchase a good or service: Technically, here you are selling your crypto for dollars, then using the dollars to pay for a good or service. In the selling, capital gains taxes may apply.
- Converting one cryptocurrency to another (exchanging cryptos): Converting or exchanging one crypto for another is selling the one to purchase the other. As a result, you may have to pay tax on the sale of the first crypto.
- Being paid by an employer in cryptocurrency: Even if you get paid in crypto, it will get taxed as income.
- Mining cryptocurrency: Proceeds from mining are typically taxed as income. It’s also possible for some miners to be taxed as a business.
- Crypto is acquired via an “airdrop” or “hard fork”: In the event of a hard fork that results in new coins, those new coins are taxed as income.
Make no mistake about it, if a return is generated—positive or negative—or some type of income is realized from holdings, your crypto will need to be reported to the IRS. This is why it’s important to keep track of any and all crypto transactions.
Many crypto exchanges will keep track of an investor’s transaction history (like a brokerage would with stocks). But it’s not a bad idea to make individual notes, too. Or, if you’re not quite sure what to do, consult a professional.
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Filing crypto taxes
When it comes to filing and paying taxes on cryptocurrency, here are the steps that should be taken.
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1.Determine what, if anything, is owed
Reference the list of above to check if any of your transactions may have generated a tax liability. If so, it’s likely you’ll have a return to report to the IRS.
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2.Record and report transactions
These will need to be reported on your tax return (your exchange can likely provide these in a document for you.) This is a paper trail for the IRS to follow.
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3.File the correct forms with your tax return
The IRS requires specific forms depending on the activity an individual has conducted with their crypto. That could include making calculations on Form 8949 and then reporting the results on Schedule D of Form 1040 , which outlines and summarizes capital gains or losses. Or, Form 1099-MISC , which is used to report income from rewards if the amount exceeds $600 for the year.
If you do owe taxes as a result of your crypto investing activity, you can pay the IRS directly. But since crypto taxes can be complicated, don’t be shy about reaching out to a professional for help.
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How to Lower Crypto Tax Liability
When it comes to lowering your crypto tax liability, many of the same strategies that are used against traditional investments, like stocks, apply to crypto holdings. Here are a few examples:
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1. Buy and Hold
The buy-and-hold strategy is simple: The longer an investor holds on to their crypto, the lower their potential tax bill when they do eventually exchange it for cash. If it was held for a year or longer, then long-term capital gains tax rates apply On the other hand, if the investor sells their crypto after holding it for less than a year, then short-term rates apply
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2. Tax-loss Harvesting
If a loss is realized on a crypto holding, it can be used to offset the gains made on other holdings. This is called “tax-loss harvesting,” and is a common tactic used to lower tax liabilities on other investments. Investors can use tax-loss harvesting to offset as much as $3,000 in non-investment income.
One thing to keep in mind, though, is that if crypto is somehow stolen or lost, investors are out of luck. They won’t be able to apply the loss against their gains to lower their liability.
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3. Charitable Donations
The IRS classifies crypto as property, and property donations are tax-deductible and not subject to capital gains taxes.
Here’s how this might work in an investor’s favor: If an investor bought a Bitcoin for $10,000 and it now has a value of $35,000, they would owe capital gains taxes on that $25,000 gain. By donating it, they can avoid those capital gains taxes and also take a deduction “generally equal to the fair market value of the virtual currency at the time of the donation if you have held the virtual currency for more than one year,” according to the IRS.
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Depending on the circumstances, crypto may be taxed as income, or as property.
Cryptocurrency taxes are very real, as are the consequences of ignoring tax liabilities. There are stiff penalties for people who are caught avoiding or otherwise failing to report investment income.
But by keeping track of your crypto holdings and transactions, managing your cryptocurrency tax liabilities shouldn’t be too difficult. As always, you can and should contact a professional if you feel like you’re in over your head.
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