Unfortunately, investing isn’t always about positive price growth. Any investor will tell you that the taxman eventually comes to collect his due. This fact isn’t any different for cryptocurrencies.
So, how are you taxed on cryptocurrencies in the United States? Do the rules for crypto taxes line up with other asset classes? Let’s take a look at what events trigger a taxable event with cryptocurrencies to figure out how to best report and maximize gains in this exciting new asset class.
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What Is Crypto?
Cryptocurrency is a digital currency secured using blockchain cryptography. These virtual currencies transact between digital wallets, which get confirmed by an algorithm before being stored in sections, or blocks, on the blockchain.
Not all cryptocurrencies are the same. For example, some of these currencies, such as Ethereum, are the foundation for an ecosystem. Others, such as Bitcoin, are for financial transactions or for storing value digitally. Finally, some of these cryptocurrencies are stablecoins, which have their price linked to a physical asset like the U.S. dollar or an ounce of gold.
Regardless of a cryptocurrency’s usage, they act the same way. Transactions between the wallets confirm on the chain, and the associated wallets with the funds change in response.
Do You Pay Taxes on Crypto?
Many of the transactions that you make using cryptocurrencies create a taxable event. This is because the IRS classifies cryptocurrency as a property, which follows a similar set of rules to other asset classes like stocks or bonds.
The first thing to know is that buying a cryptocurrency with regular money is not a taxable event. You can buy and even hold onto cryptocurrencies without paying taxes, even as the price goes up. Only taxable events create the need to report crypto transactions, not buying into the asset class itself.
To ensure that cryptocurrency investors pay their fair share in taxes, people who file taxes in a given year must report their transactions on Form 1040. Crypto exchanges also file Form 1099-K for their investors under certain criteria:
- The investor had more than 200 transactions over the tax year in question
- The investor’s total trading volume was equal to or more than $20,000 for the tax year as of 2016.
Also, the House of Representatives recently signed a bill that would require those that help broker exchanges in cryptocurrency to report their transactions. This bill is an attempt to close up loopholes or gaps in the tax revenue generated by those using some of the newer cryptocurrency applications like decentralized finance apps and DAOs.
Ultimately, the point is that if you make money off of trades or receive cryptocurrency in exchange for goods or services, that creates a taxable event that has to be reported to the IRS.
The 2021 Tax Rates for Crypto
Much like with other tax rates, cryptocurrency tax rates depend on your income, tax filing status, and how long you held the cryptocurrency before selling it. But, before we can figure out how much you owe, we have to establish your cost basis.
A cost basis refers to how much you paid for an asset when you got it. When you later sell that asset, you ideally sell it for a net profit. The only way to know that is if the cost basis for the asset was lower than the new price you sold it at.
If you sell an asset for a price lower than your cost basis, you realize a loss. In other words, you achieve a net reduction in money since you paid more for the asset than what you got out of it. Likewise, if you sell for a higher price than what you paid, you made a profit. You only incur a taxable event when you realize a gain, not a loss.
So, with that said, the next thing we need to figure out is if the cryptocurrency was a short-term or long-term capital gain. To put it simply, a long-term capital gain is when you sell an asset for a profit after holding the asset for a year or longer. The United States tax code incentivizes a longer time horizon for holding assets by making the tax rates for long-term gains lower.
For example, here are the short-term capital gains tax rates:
- 10% tax rate: $0-$9,950 for single individuals, $0-19,900 for married couples
- 12% tax rate: $9,951-$40,525 for single individuals, $19,901-$81,050 for married couples
- 22% tax rate: $40,526-$86,375 for single individuals, $81,051-$164,900 for married couples
- 24% tax rate: $86,376-$164,925 for single individuals, $172,751-$329,850 for married couples
- 32% tax rate: $164,926-$209,425 for single individuals, $329,851-$418,850 for married couples
- 35% tax rate: $209,426-$523,600 for single individuals, $418,851-$628,300 for married couples
- 37% tax rate: >$523,600 for single individuals, >$628,300 for married couples
If these ranges look familiar, that’s because they are the same brackets for earned income in the United States. Short-term capital gains are treated as earned income in the United States, making short-term trades more highly taxed depending on how much you make in a year from exchanging cryptocurrencies.
Meanwhile, here are the long-term capital gains rates:
- 0% tax rate: $0-$40,000 for single individuals, $0-$80,000 for married couples
- 15% tax rate: $40,001-$445,850 for single individuals, $80,001-$501,600 for married couples
- 20% tax rate: >$445,850 for single individuals, >$501,600 for married couples
So, compared to short-term capital gains, long-term capital gains are much cheaper. The tax brackets are also much broader.
How To Figure Out If You Taxes on Your Crypto
To put it simply, you owe taxes from your cryptocurrency transactions when you use your cryptocurrency after it has gained value from when you bought it. You also owe taxes when you receive cryptocurrency for services or goods rendered.
To keep everything straight, here are some examples of when you would owe taxes on crypto:
- Selling cryptocurrency for fiat currency: When you convert your crypto back to fiat currency, you have to pay either short-term or long-term capital gains, depending on how long you held the crypto.
- Using crypto to buy goods or services: Buying things with crypto that has increased in value is considered a trade, thus creating a taxable event.
- Trading different cryptocurrencies: Exchanging between cryptos means that you can create a taxable event if the original crypto went up in value before starting the trade.
- Receiving cryptocurrency as a payment: If you get paid for your work or goods in crypto, that is considered income and has to be reported to the IRS.
- Mining cryptocurrencies and obtaining rewards: Rewards from mining Proof of Work (PoW) cryptocurrencies are considered income.
- Staking cryptocurrency and obtaining rewards: Just like mining, staking Proof of Stake (PoS) cryptocurrencies generates rewards, which is considered income.
- Lending crypto and receiving interest payments: Interest payments you get from loaned assets are considered earned income, so be prepared to report it as such for the IRS.
If you’re not sure if you would owe taxes or not on a crypto exchange, it’s better to log the exchange and speak to a tax professional. A professional, such as a CPA, will be able to help you figure out your total tax burden from your crypto assets and what you can do to better log your crypto exchanges for future tax years.
How To Report Crypto Taxes for 2021
Much like everything else in the tax world, cryptocurrencies have their own form that you have to fill out. For crypto, this is Form 8949, which is filled out for each currency that you trade or buy during the year.
To fill out the form, you have to provide the following for each crypto you traded:
- Name of the cryptocurrency
- The date you bought the crypto
- The date you sold, traded, or otherwise got rid of it
- The proceeds or sale price of the crypto when you get rid of it
- The initial cost basis of the crypto
- Our net profit or loss from the trade
As you can imagine, this can be a tedious process for folks that trade a lot. This is why many centralized exchanges compile this data automatically each year for their users, similar to brokerage apps with stocks.
Summary
Just like other asset classes, cryptocurrencies can create taxable events for those that exchange or sell them. These trades only create a taxable event when the trade results in a profit.
However, crypto has its own unique rules, thanks to the fact that you can earn cryptocurrencies by mining or staking them. While logging all of this information can be a pain, it is necessary to make sure that you are reporting the correct income to the IRS each year. No one wants to receive an audit, so do what you can and always be honest!