According to the Internal Revenue Service (IRS), most cryptocurrencies are convertible virtual currencies.This means that they act as a medium of exchange, a store of value, a unit of account, and can be substituted for real money.
It also means that any profits or
income created from your cryptocurrency is taxable.However, there is much to unpack regarding how cryptocurrency is taxed because you may or may not owe taxes in given situations.If you own or use cryptocurrency, it’s important to know when you’ll be taxed so you’re not surprised when the IRS comes to collect.
– If you sell cryptocurrency and profit, you owe capital gains on that profit, just as you would on a share of stock.
– If you use cryptocurrency to buy goods or services, you owe taxes on the increased value between the price you paid for the crypto and its value at the time you spent it, plus any other taxes you might trigger.
– If you accept cryptocurrency as payment for goods or services, you must report it as business income.
– If you are a cryptocurrency miner, the value of your crypto at the time it was mined counts as income.
When Is Cryptocurrency Taxed?
Cryptocurrencies on their own are not taxable—you’re not expected to pay taxes for holding one.
The IRS treats cryptocurrencies as property for tax purposes, which means:
– You pay taxes on cryptocurrency if you sell or use your crypto in a transaction, and it is worth more than it was when you purchased it.This is because you trigger capital gains or losses if its market value has changed.
– If you receive crypto as payment for business purposes, it is taxed as business income.
– If you successfully mine a cryptocurrency or are awarded it for work done on a blockchain, it is taxed as ordinary income.
How Do Cryptocurrency Taxes Work?
Because cryptocurrencies are viewed as assets by the IRS, they trigger tax events when used as payment or cashed in.When you realize a gain—that is, sell, exchange, or use crypto that has increased in value—you owe taxes on that gain.
For example, if you bought 1 BTC at $6,000 and sold it at $8,000 three months later, you’d owe taxes on the $2,000 gain at the
short-term capital gains tax rate.Profits on the sale of assets held for less than one year are taxable at your usual tax rate.
For the 2023 tax year, that’s between 0% and 37%, depending on your income.
If the same trade took place a year or more after the crypto purchase, you’d owe long-term capital gains taxes.Depending on your overall taxable income, that would be 0%, 15%, or 20% for the 2023 tax year.
In this way, crypto taxes work similarly to taxes on other assets or property.They create taxable events for the owners when they are used and gains are realized.That makes the events that trigger the taxes the most crucial factor in understanding crypto taxes.
Types of Cryptocurrency Tax Events
Taxable events related to cryptocurrency include:
– Sale of a digital asset for fiat
– Exchange of a digital asset for property, goods, or services
– Exchange or trade of one digital asset for another digital asset
– Receipt of a digital asset as payment for goods or services
– Receipt of a new digital asset as a result of a hard fork
– Receipt of a new digital asset as a result of mining or staking activities
– Receipt of a digital asset as a result of an airdrop
– Any other disposition of a financial interest in a digital asset
The following are not taxable events according to the IRS:
– Buying cryptocurrency with fiat money
– Donating cryptocurrency to a tax-exempt non-profit or charity
– Making
a gift of cryptocurrencyto a third party (subject to gifting exclusions)
– Transferring cryptocurrency between wallets
Examples of Cryptocurrency Tax Events
Make a Purchase With Crypto
Making a purchase with your crypto is easier than ever.
However, this convenience comes with a price; you’ll pay sales tax and create a taxable capital gain or loss event at the time of the sale.Here’s how it would work if you bought a candy bar with your crypto:
– You transfer the crypto to the merchant through your wallet to theirs, including the sales tax.
– If your crypto’s value is higher than when you purchased it, you have created a taxable event with a realized capital gain.If it’s less, you have a capital loss.Each needs to be reported at tax time.
– Because it’s a taxable event, you should log the amount you spent and its fair market value at the time of the transaction for your records.
So, you’re getting taxed twice when you use your cryptocurrency if its value has increased—sales tax and capital gains tax.
Buying Cryptocurrency
Say you bought one bitcoin (BTC) for about $3,700 in early 2019.In late February 2022, 1 BTC was worth $38,500.You could have used it to buy a car.
There are tax implications for both you and the auto seller in this transaction:
– The seller must report the transaction as gross income based on bitcoin’s fair market value at the time of the transaction.
– The seller must also realize a capital gain or loss when they exchange the bitcoin for fiat currency or use it as payment.
– You must report the transaction as a capital gain because you’ve cashed out an investment to buy something.
The gain is the difference between the price you paid for the bitcoin and its value at the time of the transaction.
Cashing Out Cryptocurrency
When exchanging cryptocurrency for fiat money, you’ll need to know the cost basis of the virtual coin you’re selling.The
cost basis for cryptocurrency is the total price in fees and money you paid.When you exchange your crypto for cash, you subtract the cost basis from the crypto’s fair market value at the time of the transaction to get the capital gains or loss.
The amount left over is the taxable amount if you have a gain or the reportable amount if you have a loss.
Similar to other assets, your taxable profits (or losses) on cryptocurrency are recorded as capital gains or capital losses.
Cryptocurrency Mining
The rules are different for those who
mine cryptocurrency.Cryptocurrency miners verify transactions in cryptocurrency and add them to the blockchain.They’re compensated for the work done with rewards in cryptocurrency.
Their compensation is taxable as ordinary income unless the mining is part of a business enterprise.If the crypto was earned as part of a business, the miners report it as business income and can deduct the expenses that went into their mining operations, such as mining hardware and electricity.
Exchanging Cryptocurrencies
Exchanging one cryptocurrency for another also exposes you to taxes.
For example, if you buy one crypto with another, you’re essentially converting one to fiat and then purchasing another.You’ll need to report any gains or losses on the crypto you converted.
Many
exchanges help crypto traders keep all this information organized by offering free exports of all trading data.The trader, or the trader’s tax professional, can use this to determine the trader’s taxes due.
Cryptocurrency Tax Reporting
To be accurate when you’re reporting your taxes, you’ll need to be somewhat more organized throughout the year than someone who doesn’t have cryptocurrency.For example, you’ll need to ensure that with each cryptocurrency transaction, you log the amount you spent and its market value at the time you used it so you can refer to it at tax time.
Cryptocurrency brokers—generally crypto exchanges—will be required to issue 1099 forms to their clients for tax year 2023 to be filed in 2024.
You can do this manually or choose a
blockchain solution platform that can help you track and organize this data.For example, platforms like CoinTracker provide transaction and portfolio tracking that enables you to manage your digital assets and ensure that you have access to your cryptocurrency tax information.
Cryptocurrency capital gains and losses are reported along with other capital gains and losses on
IRS form 8949, Sales and Dispositions of Capital Assets.If you’re unsure about cryptocurrency taxes, it’s best to talk to a certified accountant when attempting to file them, at least for the first time.
How Much Tax Do I Owe on Crypto?
How much tax you owe on your crypto depends on how much you spend or exchange, your income level and tax bracket, and how long you have held the crypto you used.For example, if you spend or sell your cryptocurrency, you’ll owe taxes at your usual income tax rate if you’ve owned it less than one year and capital gains taxes on it if you’ve held it longer than one year.If you received it as payment for business services rendered, it is taxable as income at market value when you acquired it and taxable again when you convert it if there is a gain.
How Can I Avoid Paying Taxes on Crypto?
There are no legal ways to avoid paying taxes on your crypto except not using it.
You’ll eventually pay taxes when you sell it, use it, convert it to fiat, exchange it, or trade it—if your crypto experienced an increase in value.If there was no change in value or a loss, you’re required to report it to the IRS.
Do I Pay Taxes on Crypto If I Don’t Sell?
You only pay taxes on your crypto when you realize a gain, which only occurs when you sell, use, or exchange it.Holding a cryptocurrency is not a taxable event.
The Bottom Line
Cryptocurrency taxes are complicated because they involve both income and capital gains taxes.In most cases, you’re taxed multiple times for using cryptocurrency.
With that in mind, it’s best to consult an accountant familiar with cryptocurrency and current practices to ensure you’re reporting taxes correctly.
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