How is cryptocurrency taxed?

To some intending cryptocurrency investors, it's unclear how - or if at all - cryptocurrency is taxed. Although not regarded as common Fiat like the dollar, pound, or Euro - cryptocurrency is still subject to tax.

The IRS classifies all cryptocurrencies - such as Bitcoin - as property. This means your crypto will be taxed the same way as your other property and assets, such as stocks, gold, or bonds.

Of course, crypto offers a lot of benefits, but exemption from paying tax is certainly not one of them. The IRS requires a report of user's activity on gains and losses. As a capital asset, cryptocurrency is considered as a property under the federal income tax and a holder is required to pay taxes on gains.

Popular cryptocurrency logos

Do you have to pay taxes on cryptocurrency?

The answer is undoubtedly yes. Since cryptocurrency is categorized as an asset, it has clear tax implications. All bitcoin transactions, no matter how small in value, must be reported to the IRS. The U.S. tax code requires that all bitcoin transactions, including purchases, sales, investments, and use, be recorded.

When you first purchase cryptocurrency, you will not pay tax. You will not pay tax even if you hold your digital currency into the next tax year. The taxation begins when your cryptocurrency is traded, or used as part of an exchange. This means selling your crypto, using it as the method for a purchase, or even exchanging one cryptocurrency for another.

When dealing in cryptocurrency, the important thing you need to remember is that you are responsible for keeping track of all your potentially taxable activities and their fair market value.

Fair Market Value (FMV)

You should know - fair market value (FMV) is the price that an asset would sell for on the open market.

Taxes on Cryptocurrency Gains

Since profit on capital assets is taxed, when cryptocurrency is sold/withdrawn after increasing in value, the profit is taxed. For example, if you bought any form of cryptocurrency (Bitcoin, Ethereum, Dogecoin, or BNB) at $7000, if you sold the same cryptocurrency later at $11,000, $4,000 will be your taxable gain.

Graphic how cryptocurrency gains are taxed

Gains on cryptocurrencies are taxed at a federal rate from 0% to 37%. Additionally, other credits, exemptions, deductions, which can lower overall taxable income, could affect the exact tax rate.

Taxes on Cryptocurrency Losses

Losing money on your crypto investments is tough, but there are some tax benefits later on. If you buy a cryptocurrency at $7,000 and sell at $5,000 then you'll owe nothing. Instead, you can use the part of the loss as a counterbalance for other investment gains.

Graphic how cryptocurrency losses are taxed

You can use your crypto losses to offset capital gains from other investments. There are also instances in which you may qualify for tax deductions from your crypto loss. You should always declare losses on your tax returns, to make sure you are reducing your tax liability as much as possible.

Paying Tax on Purchases Made with Cryptocurrency

What if a purchase was made with crypto? Well, tax still applies. For example, if you invested $50 in crypto and it rises to $150, then you bought goods worth $150 you'd owe capital gain taxes on the $100 profit. Even purchasing coffee or lunch with your favorite cryptocurrency will be subject to taxation.

The taxes will, of course, vary depending on the details of the transaction, such as the cryptocurrency's value at the time of sale and the price of the transaction.

Calculating Cryptocurrency Tax

The length of time for which a cryptocurrency is held determines the tax on it. There are short-term gains and long-term gains or losses and each affects how much you pay as taxes on the cryptocurrency.

Short Term Capital Gain & Loss of Crypto

A purchase and sale of cryptocurrency within a year is a short-term investment. If you sell and make a profit, then it's a short capital gain that is taxed as income tax (wages or salaries determined tax bracket). If the sale results in a loss, then it's a short-term capital loss.

Long Term Capital Gain & Loss of Crypto

A long-term capital gain is an increase in a cryptocurrency investment over a year. Any type of crypto purchased and sold after a year with profits is long-term capital gain and if a loss is incurred then it is a capital loss. Taxes on long-term gains are taxed lower than short-term types. The rate which ranges from 0% to 20% depends on the income.

Crypto Mining and Airdrops Taxation

Unlike the purchase of cryptocurrency, mined crypto is taxable as soon as it is mined. There is no need to sell use the crypto or use it in an exchange, it is taxable immediately.

Crypto mining takes the form of taking on tasks and getting rewards. Payment received in the form of crypto as a reward is taxable. When you mine a coin, its fair market value - or value of which will be taxed - is the price at which you mined it. 

The same applies to airdrop rewards. The value of the airdrop is considered a taxable income.

 Fortunately, mining equipment and resources are expenses that may be deductible for business purposes. You can deduct different things depending on whether you mined cryptocurrencies for yourself or for others. 

Receiving Crypto as Payment for Goods or Services

If you receive crypto payment as payment for goods and services then it's deemed as income just as if the payment was made with cash.

Hence, your earning will be taxed as your regular income. Cryptocurrencies have value based on the day at which they were used for payment, otherwise known as their cost basis. This is the value that you will need to report on your tax returns.

Crypto Conversion Taxation

If you convert a certain cryptocurrency to another and make gains, you'll pay taxes on the profit.

In the past, it was believed that the conversion of one cryptocurrency to another was classified as a like-kind transfer. The IRS, however, has now deemed that crypto exchanges do not qualify as like-kind transfers. This means that there will be tax implications from each conversion.

How to Prepare for Taxes When You Own Crypto

Whether or not your crypto activities are complex, you must speak with a tax professional. The right help will ease any questions you have regarding your specific tax obligations or whether you are reporting correctly. Tax professionals are experienced with interpreting the tax code regarding virtual currencies.

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