Managing Your Crypto Taxes: A Guide for Investors
Cryptocurrency investing has exploded in popularity over the last few years. With exciting new projects launching and prices fluctuating wildly, it’s no wonder so many have jumped on the crypto bandwagon.
However, this exciting new asset class also comes with some unique tax implications that investors need to understand. Failure to properly track and report crypto activity can lead to headaches, audits, and penalties down the road.
This guide will walk through the key crypto tax rules in plain English, as well as offer tips on record keeping and planning to minimize your tax bill. Mastering crypto taxes takes some work up front, but will save you time, money, and stress over the long run.
Crypto Is Treated as Property by the IRS
The first thing to understand is that the Internal Revenue Service (IRS) considers virtual currencies like Bitcoin and Ethereum as property for tax purposes. This means the same general tax principles that apply to stocks, bonds, and real estate also apply to crypto.
Some investors mistakenly believe crypto is completely anonymous and untraceable by the IRS. However, this is not the case. The IRS has been ramping up enforcement and now directly asks about crypto activity on standard tax forms.
While the crypto ecosystem does offer more privacy than traditional finance, the IRS has ways to connect activities back to individuals. Understanding the tax rules now can help avoid headaches later if the tax man comes knocking.
Selling Crypto for Profit Generates a Tax Bill
The most common taxable crypto event is selling cryptocurrency for a gain. Let’s walk through an example:
- You purchased 1 Bitcoin for $10,000 in January
- In June, you sold 0.5 Bitcoin for $7,000 with the help of Immediate Alpha (see here https://www.indexuniverse.eu/immediate-alpha-review/) and the other 0.5 Bitcoin for $7,000 on Gemini ( see here https://www.gemini.com/)
Selling the Bitcoin generated a $4,000 capital gain. Just like stock gains, you owe capital gains taxes on the difference between the sale price and the original purchase price.
The exact tax rate depends on how long you held the asset:
- Short-term gains – for assets held less than one year – are taxed at your ordinary income tax rate
- Long-term gains – for assets held over one year – are normally taxed at more favorable long-term capital gains rates
You may also be able to use crypto losses to offset gains. If you sold Bitcoin at a loss, it could potentially offset capital gains from other sources. Short term losses can even offset up to $3,000 of ordinary income.
Other Taxable Crypto Events
Selling for a gain is the most common taxable event, but there are others to be aware of as well:
- Trading crypto for crypto – Trading one currency for another is treated as a sale, even if you don’t convert back to cash
- Getting paid in crypto – Receiving cryptocurrency for goods or services is treated as ordinary income
- Air drops – Free coins awarded from a protocol are treated as income
- Mining – Mining coins is treated as income equal to the fair market value
- Spending crypto – Using crypto to buy goods or services is a sale of that crypto
The important thing is to treat crypto as you would any other property for tax purposes. If you sell, spend, or get paid in crypto, there is likely a tax implication that needs to be reported.
Proper Record Keeping Is Critical
Since cryptocurrency users are responsible for calculating and reporting any taxes owed, keeping accurate records is critical. Every single transaction needs to be tracked and documented.
- The date of the transaction
- The purchase/sale price
- The cryptocurrency amount transacted
- Which currency was involved
Record keeping is the biggest challenge for crypto investors. Without accurate histories, calculating gains, losses, and income can quickly become an impossible mess.
Fortunately, there are tools available to help. Here are some options for tracking transactions:
- Cryptocurrency exchanges – Many exchanges like Coinbase provide transaction histories and some even generate tax reports
- Wallets – Some wallet apps have record keeping features or exportable reports
- Tracking websites – Services like Cointracker allow users to link exchanges and wallets to generate tax forms
- Spreadsheets – Savvy users can track transactions manually with a spreadsheet
While tracking down historical details can be tedious, taking the time up front will save major headaches at tax time. Don’t wait until April to start organizing your crypto tax records.
Tax Planning Opportunities
With the right planning, crypto investors do have some opportunities to potentially lower tax bills. Here are a few strategies to consider:
Tax Loss Harvesting
Tax loss harvesting involves strategically selling crypto assets that have experienced losses. These losses can offset capital gains from other sources, lowering total tax liability.
For example, say you have a $5,000 loss on Ethereum but a $3,000 gain on Bitcoin. If you sell the Ethereum to realize the loss, it negates the Bitcoin gain and an additional $2,000 of income.
Loss harvesting makes the most sense for assets held short term since the losses offset income taxed at higher ordinary rates.
Long Term Holding
For cryptocurrencies with long term growth potential, holding them over one year to qualify for long term capital gains taxes can be a wise move.
Long term rates of 0%, 15% or 20% are much more favorable than short term ordinary income rates which can climb as high as 37%.
This strategy involves more risk since crypto is volatile, but can generate tax savings for investors with a longer time horizon.
Donating Crypto Directly
Donating cryptocurrency directly to a nonprofit organization can make sense for philanthropically inclined investors.
Doing so allows you to avoid capital gains taxes since the crypto is never converted to cash. You can deduct the full fair market value of the donation against regular income.
Additionally, donating crypto held over one year allows the donation to be deducted at fair market value vs the lesser of fair market value or cost basis.
Tax Deferred Retirement Accounts
While the IRS limits what can be held in a IRA or 401k, some cryptocurrencies are eligible.
Holding crypto in a retirement account allows gains to grow tax deferred. However, required minimum distributions must still be taken at age 72 and will be taxed.
Investors must be careful to only purchase permitted crypto assets within retirement accounts to avoid penalties.
The Bottom Line
- Crypto is treated as taxable property according to the IRS
- Gains, income, spending, and donations often generate tax obligations
- Keeping thorough records is critical to stay compliant
- Some planning opportunities exist to minimize taxes
While crypto taxes can be complicated, a bit of up front planning goes a long way. Gain a full understanding of the tax implications, be diligent about record keeping, and use a reputable accounting professional if needed. Mastering crypto taxes will allow you to focus on your investments instead of stressing about the IRS.
Frequently Asked Questions About Cryptocurrency Taxes
What percentage of cryptocurrency gains are taxed?
The percentage tax rate on cryptocurrency gains depends on how long the asset was held:
- Short term gains – for assets held less than 1 year – are taxed at your ordinary income tax rate, up to 37%
- Long term gains – for assets held over 1 year – are taxed at more favorable long term capital gains rates of 0%, 15% or 20%
Does buying crypto trigger a taxable event?
No, simply purchasing cryptocurrency with fiat currency is not a taxable event according to the IRS. Taxes are only triggered when selling, trading, or otherwise disposing of cryptocurrency in exchange for goods, services, or converting to fiat currency.
Can I deduct my crypto losses?
Yes, capital losses from cryptocurrency can be used to offset capital gains from other sources to lower your overall tax liability. Up to $3,000 of excess net losses can even be deducted against ordinary income.
Do I have to report if I only made small crypto transactions?
Yes, you must report all cryptocurrency transactions no matter how small. There is no minimum threshold for reporting to the IRS. Even spending small amounts of crypto to buy goods and services needs to be reported.
What if I don’t report my crypto taxes?
Failure to report cryptocurrency transactions can lead to penalties, fees, and increased likelihood of an audit if the IRS identifies a discrepancy. Intentionally avoiding reporting crypto activity altogether can potentially trigger criminal tax fraud charges.
Do crypto exchanges report to the IRS?
In most cases, yes major exchanges like Coinbase, Kraken, and Gemini issue 1099 forms to users who exceed $600 in transactions. However, even with smaller amounts you still need to self report any taxable events.
How long should I keep my crypto tax records?
The IRS recommends keeping tax records for at least 3 years after filing your returns. However, given crypto’s volatility it is recommended keeping records for 5 years or longer in case of an audit. Records substantiating the cost basis of coins are crucial.
Can I get an extension to file my crypto taxes?
Yes, you can get an automatic 6 month extension to file your taxes by submitting Form 4868. This moves the filing deadline from April to October. However, any taxes owed are still due in April – the extension is for filing the return only.
Key Crypto Tax Regulations and Rules
The IRS first released guidance on virtual currency tax treatment in 2014, stating cryptocurrencies would be treated as property for tax purposes. This key ruling means crypto is taxed similarly to other forms of investment income.
In 2019, the agency released additional guidance in a set of FAQs covering the tax implications of common crypto transactions including:
- Trading one coin for another
- Getting paid in crypto for goods or services
- Mining and staking rewards
- Air drops
- Hard forks
Staying up to date on the latest IRS rules can help crypto investors avoid surprises and properly comply with reporting requirements.
Form 1040 Reporting
In 2020, the IRS began asking about virtual currency transactions directly on Form 1040. Taxpayers must answer the question:
„At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?“
Checking Yes triggers follow up questions about specifics amounts involved. This change signals increased IRS enforcement focus on cryptocurrency reporting.
Even checking No requires certifying under penalty of perjury no crypto activity occurred. Falsely reporting can lead to tax evasion charges.
Revised 1099-MISC Reporting
In early 2022, the IRS changed regulations surrounding which crypto transactions require issuance of a 1099-MISC form.
Previously, exchanges only issued 1099’s if users exceeded 200 transactions. The revised rule lowers the threshold to just a single transaction if value exceeds $600.
If you receive a 1099-MISC, be sure to also report it on your tax return to avoid IRS notices. However, you must still report income even without receiving a 1099 form.
State Level Guidance
In addition to federal taxes, some U.S. states have issued their own cryptocurrency tax guidance:
- California – Issues Form 585 to report transactions
- New Jersey – Crypto is taxable as property
- New York – Transactions over $10,000 must be reported
- Texas – Exempts crypto from state sales tax
Check with your home state’s tax authority to understand requirements beyond federal rules. Some cities may also levy local taxes.
Penalties for Non-Compliance
The IRS has made it clear crypto taxes cannot be ignored without consequences:
- Failure to report income may trigger federal perjury charges
- Underpayment penalties can accrue monthly at 5% of unpaid tax
- Audits are likely if taxable activity is uncovered
- Criminal tax evasion charges are possible in extreme cases
Don’t take crypto tax obligations lightly. IRS enforcement capabilities are growing in this area each year.
Cryptocurrency Tax Filing Tips and Strategies
Use a Crypto Tax Calculator
Manually tracking every transaction across multiple exchanges and wallets can quickly become extremely tedious. Crypto tax calculators can automate this process by linking to your transaction histories and generating necessary tax forms.
Calculators range from free versions for simple users to paid platforms with advanced features for active traders. Be sure to use one tailored to your specific needs.
Choose a Cost Basis Method
When valuing crypto sold, you must choose a cost basis method to identify which specific coin is considered sold. This determines gain/loss calculations.
Common methods include:
- FIFO (First In First Out): Earliest acquired coins are considered sold first
- LIFO (Last In First Out): Newest coins are considered sold first
- HIFO (Highest In First Out): Highest cost coins are sold first
- LOFO (Lowest In First Out): Lowest cost coins are sold first
There are benefits to each depending on your situation. Consistency across years is important.
|Cost Basis Method||Pros||Cons|
|FIFO||Matches cash flow order||Taxes early holdings at low cost|
|LIFO||Defers taxes by selling newest holdings first||Difficult to track with manual records|
|HIFO||Maximizes losses for tax benefits||Gains taxed at highest rate|
|LOFO||Minimizes gains by selling low cost holdings||Larger gains may be deferred|
File for Tax Deadline Extensions
The tax filing deadline for most individuals is April 15. However, you can automatically extend the deadline 6 months by filing Form 4868.
This moves the deadline to October 15, giving you more time to collect records and obtain professional help. An extension does not delay payment of taxes you owe though.
Consider Using a Crypto IRA
Holding cryptocurrency in a self-directed IRA allows gains to grow tax deferred like a normal retirement account.
Certain crypto assets can be held in the IRA without triggering a taxable event. The downside is required minimum distributions still apply at age 72.
File Amended Returns for Prior Years
Have past year crypto transactions that were not reported properly? File amended returns using Form 1040-X to correct mistakes and avoid penalties for previous tax years.
Look back up to 3 years to claim any refunds due from overlooked losses or deductions. Pay any additional tax owed to avoid late fees.
Deduct Transaction Fees
Don’t forget transaction fees paid to exchanges are deductible as investment expenses.
Save detailed records of any fees related to purchases, sales, withdrawals, deposits and transfers to claim these deductions.
For very active traders, a mark-to-market election can simplify tracking by requiring all positions be marked to fair market value annually.
Gains and losses are then calculated based on the change in value each year rather than tracking individual transactions.Requirements must be met to qualify for the election.
Donate Appreciated Crypto
Gifting cryptocurrency held over one year to a qualifying charity eliminates capital gains tax that would otherwise be due on the appreciation.
You also get a deduction for the fair market value of the donation against regular income. The charity receives the full upside benefit.
Watch for Air Drops
Air drops of new coins are treated as ordinary income equal to the value upon receipt. Holding the coin does not defer this tax liability.
Keep records of any air drops received by tracking wallet addresses. Some may be negligible, but popular drops have meaningful value.
Diversify Among Asset Classes
Balancing cryptocurrencies with stocks, bonds, real estate and cash can minimize the tax drag from holding primarily one asset class.
Each class has differing tax treatment – spreading assets smooths taxes by avoiding overexposure to one set of rates. Diversification also reduces risk.
- Cryptocurrency tax rules continue evolving – monitor IRS guidance
- Income, trading gains, air drops and spending crypto all create tax obligations
- Maintaining meticulous transaction records is essential
- Tax planning maneuvers can help lower bills for savvy investors
- Don’t delay – start compiling your tax records early
Cryptocurrencies offer exciting growth potential, but also generate complex tax reporting requirements. However, armed with the guidance above and professional tax help, crypto investors can confidently navigate tax season.
The extra time invested up front organizing records helps avoid overpaying taxes or IRS audits down the road. As crypto adoption grows, expecting increased enforcement of reporting rules. Take control of your tax situation now and reap the rewards for years to come.