If you are a shareholder in cryptocurrencies, or just have a few that you’ve been holding for eventually, then it might be time to do your taxes. Cryptocurrency is taxed differently than stocks and bonds are because it’s not as well understood yet. This blog post will go along with the basics of how cryptocurrency taxes work so that you know what to expect when April rolls around.
Table of Contents
- Cryptocurrency and Taxes: What You Need to Know
- How is Cryptocurrency Taxed?
- Do I Owe Taxes on Cryptocurrency?
- IRS Treatment of Cryptocurrency
- 7 Things You Need to Know About Cryptocurrency Taxes
- You’ll be Asked Whether You Owned or Used Cryptocurrency
- You Don’t Escape Being Taxed Just Because You Didn’t Get a 1099
- Just Using Crypto Exposes You to Potential Tax Liability
- Gains on Crypto Trading are Treated Like Regular Capital Gains
- Crypto Miners May Be Treated Differently From Others
- A Gift of Crypto is Treated the Same as Other Gifts
- Inherited Cryptocurrency is Treated Like Other Inherited Assets
Cryptocurrency and Taxes: What You Need to Know
Cryptocurrency is a type of digital money. It does not exist in the real world like cash. You cannot see, hold, or put it into your pocket like you can with cash. Digital currency was created over 10 years ago and has grown in popularity over the last few years. Instead of using a bank to process transactions, cryptocurrency uses cryptography.
First of all, we need to confirm that we understand this new kind of money. Cryptocurrency units are called coins, and they are not physical coins. You keep your coins in a digital wallet or use an exchange or brokerage service. Major providers include Binance, Coinbase, Kraken, and Toro.
Bitcoin was the first cryptocurrency. It was also the most popular until it had to share space with Ethereum and Litecoin, among many other cryptocurrencies. You can use a cryptocurrency to buy things or invest in them. You can exchange coins that represent money for traditional money, like dollars. If you want to know the price of a bitcoin, you can find it here. When people send this type of coin to one another, they record it in a big list on the internet.
Cryptocurrency as Property
If you have been using cryptocurrency without paying taxes on any of your gains from it, you are not alone. You are also not compliant with IRS regulations. This could make a difference in the future. The agency will make you pay a fine for something unless you can prove that it was your fault.
Since 2014, the IRS has been classifying cryptocurrency as property. Taxpayers are needed to report transactions involving virtual currency like US dollars on their tax returns. This means that they must determine its fair market value on the date of the transaction. You can determine the honest market value of a virtual currency by converting it to US dollars or another country’s currency. This is what happens when there are enough people who want to buy US dollars- they will have to have your money in that country’s currency.
If you use cryptocurrency, you need to do some kind of record keeping. There are many good programs to help you with that. QuickBooks is one of those programs that helps you keep track of your transactions with crypto. It is necessary to keep detailed information on all your transactions. If you have kept good records, there will be a lot less work to do when you are done.
Capital Assets and Cryptocurrency
If you sell your house or stocks, then they are considered capital assets. If you sell virtual currencies, they are also a capital asset. When you have capital assets, then it is possible that you will owe taxes for them on your Schedule D. On your taxes, you can calculate how much money you have made or lost on a currency.
You take the amount that you bought the currency for and compare it to how much it is worth now. If the value went up, then you made money. And if it decreased, then you lost money.
If you are selling property as a part of your business or trade, it is not considered to be capital. The property will be taxed as usual income. This appeals to virtual currency sales, too. The IRS glances at the “character” of the gain or loss—your intent and why you’re selling.
Cryptocurrency and TurboTax
TurboTax is the only tax preparation website that will help you with cryptocurrency sales. It walks you through the process and gives lots of guidance. This service is not included in the Deluxe version, but it is in Premier or Self-Employed, so if you want TurboTax to help with your taxes, make sure to upgrade to one of these two.
There is a thing called the cryptocurrency mini-wizard. You can find it under Investment Income. Four things would make you have to deal with this. You would do this if:
- Sold cryptocurrency
- Convert cryptocurrency to US dollars
- Exchanged one type of cryptocurrency for another.
- I used cryptocurrency to buy something, or someone paid me in cryptocurrency.
Cryptocurrency transactions sometimes need to be reported on 1099-B, 1099-K, or a tax statement. Exchanges are not needed to send these forms, but it is your responsibility to report the information on them if they do. If you do not have one from 2020, it means that the exchange did not send you one.
You can do it by downloading your trading history from the exchange. If you trade a lot, download the information every few months because your exchange may only give you three months of information. You can also enter it manually.
How is Cryptocurrency Taxed?
The IRS ruled that cryptocurrency should be managed like other assets. This is because it is not a currency. This means that people who own crypto will have to pay taxes on it, and they will be more complicated than if they were dollars or euros.
Capital assets are taxed when they are sold for a profit. When you spend money on goods or services with cryptocurrency, and the amount of crypto you spent has gone up in value over what you bought it for, then your spending will incur capital gains taxes. Let’s say you purchase $20 worth of Bitcoin, and it went up to $200.
If you used Bitcoin to buy groceries for $200, you would owe taxes on the money that changed hands. The IRS handles them as the same thing, even if it seems like you spent your coins.
Do I Owe Taxes on Cryptocurrency?
Did you mine cryptocurrency? When you use computers to solve complicated equations and record data on the blockchain, you can get new cryptocurrency tokens. You must pay taxes on the entire value of these tokens that you have received from mining.
Did you get crypto as a reward? If you receive it through a marketing promotion or an airdrop, it counts as taxable income.
Did you receive money in the form of cryptocurrency? If someone pays you with cryptocurrency for goods or assistance rendered, the entire payment counts as taxable income, just as if they rewarded you in cash. Unlike a cash payment, though, your consumer might also owe income taxes if their cryptocurrency provides them with more value than they paid for it.
Did you sell any cryptocurrency that you had bought? Did it cost less than what you sold it for? You owe tax on the gain, just like with stocks or mutual funds.
IRS Treatment of Cryptocurrency
The general rules for property transactions always apply to exchanges of cryptocurrencies. As a result, gain or loss is recognized every time cryptocurrency is exchanged or used to purchase goods and services.
Settled for Cash
Cryptocurrency gains from trading coins are treated as investment income by the IRS. The same capital-obtain rules apply. A taxpayer who trades coin position for cash must report a capital gain on Form 8949. Holding a coin for less than a year is taxed at an ordinary tax rate. Holding it for more than one year is taxed at a lower capital gains tax rate.
Capital losses offset capital gains in full. So if you have a $3000 capital loss, then you will not pay any tax on your other income. If you possess a net capital loss, then that is carried forward to the next year.
Under IRS rules, the default for stock trades is to use a first-in, first-out method of accounting. But sometimes, it is possible to pick and choose which shares you trade. The use of specific identification can reduce the amount that is recognized as a profit on cryptocurrency transactions. This is because many traders have multiple transactions in the same form of cryptocurrency.
Exchanged for Other Cryptocurrencies
People who trade cryptocurrency (e.g., they trade Bitcoin for Ethereum) may think they do not owe taxes because they did not receive any money. But the IRS thinks that cryptocurrency is property, so crypto trades are subject to the same capital acquire and losses rules as all other property exchanges.
Some people who make trades with cryptocurrency have tried to delay the income on their profit by classifying it as an IRC section 1031 like-kind exchange. They can defer the income for when they sell their next cryptocurrency. Prior to the Tax Cuts and Jobs Act of 2017, it was possible to contend that cryptocurrency could qualify. But there were built-in problems in the applicability of IRC section 1031 to these trades since they may have crashed to meet certain requirements.
Currency is not a property. This means that you can’t trade it for other properties like you would with things like furniture. You also have to do special paperwork and report the trades on Form 8824 if you want to keep them good for taxes.
People with computers can make money by solving mathematical puzzles. They get to keep the coins they find this way. What’s more, 2014-21 says that you get to keep them and count them as your own income when you find new coins. Individuals who mine cryptocurrency running a trade or business will need to pay self-employment tax on the income they earn from their activities.
The amount of this income is the market price of the coins on the day they were awarded on the blockchain. This amount also becomes your basis for all future transactions.
Payment for Goods and Services
Notice 2014-21 has information about the taxes on money that you get. It can be paid to an employee, a contractor, or someone else who sells something. The wages are taxable to the employee and must be reported on Form W-2. The value of the money is taxed at fair market value.
Payments to contractors for services with cryptocurrency are subject to income tax. If the contractor is an independent contractor, they must pay self-employment tax. The fair market value of the cryptocurrency will determine how much it is taxable. People who receive cryptocurrency as payment for goods or services (either as an employee or an independent contractor) need to include the cryptocurrency’s fair market value in their reported taxable income.
Coin Hard Forks
A hard fork is when a cryptocurrency changes in two different ways. This usually happens when a lot of people want to change the rules for the coins. Bitcoin had a hard fork on August 1, 2017, and this caused it to split into two coins: Bitcoin and Bitcoin Cash.
Each person who has a Bitcoin unit is also entitled to one Bitcoin Cash unit. Likewise, Litecoin, the fifth-largest cryptocurrency, had a hard fork in early 2018. It is called Litecoin Cash.
The IRS has not advised on hard fork trades. Tax experts and coin dealers are still debating about what the tax treatment is for these transactions. Common inquiries include: Is a hard fork the same as a stock split? If so, do you have to divide the value of coins between the original coin and the new one, or is it
Instead of trading the cryptocurrency and donating the after-tax proceeds, a taxpayer can donate it directly to a charity. This approach provides benefits: the tax deduction will be equal to the fair market value of the given coins (as determined by a qualified appraisal), and they will not have to pay taxes on this gain.
This strategy will result in more money for the charity because they will not have to pay taxes. They will obtain the full value of the donation. This strategy only works if you have held on to your coins for longer than one year.
7 Things You Need to Know About Cryptocurrency Taxes
You’ll be Asked Whether You Owned or Used Cryptocurrency
In your 2020 tax return, you will have to report if you were involved in cryptocurrency. At the top of Form 1040, it asks, “At any time during 2020, did you receive, sell, send, trade, or otherwise acquire any financial interest in any virtual currency?”
The IRS is asking if you have transacted in cryptocurrency. If you answer that question, it might be hard to remember what happened. The IRS does not like liars and tax cheats, so it will make things worse if you lie. In a recent clarification, the IRS said that taxpayers who only purchased virtual currency with real currency were not obligated to answer “yes” to the question.
You Don’t Escape Being Taxed Just Because You Didn’t Get a 1099
With a bank or brokerage, you (and the IRS) will typically get a Form 1099 reporting the income you’ve received during the year. But this might not be true with cryptocurrency.
“There is usually not the same level of reporting yet for cryptocurrency, relative to typical 1099 forms for stocks, interest, and other payments,” Harris says. “The IRS does not get great information from Coinbase and other exchanges.”
But the lack of 1099 will not let you escape any tax liability. You will still have to announce your gains and pay taxes on them, but it is not all bad news if you had to take a capital loss. You can deduct that on your return and reduce your taxable income.
Just Using Crypto Exposes You to Potential Tax Liability
When you trade your virtual currency for real currency or other things, you may have a tax obligation. If the price of your cryptocurrency is worth more than what you paid for it, then this will create a tax obligation. .If you invest in cryptocurrency and get more money than what you put into it, then you have a tax liability.
Of course, you might not make any money if the cost of your goods, services, or real currency is less than what you paid for it. Or, you could have a tax loss. You will need to know how much of it you paid to calculate this.
The cryptocurrency tax is a capital gains tax – a tax on the realized change in the value of the cryptocurrency. And like a stock that you buy and hold, if you don’t exchange the cryptocurrency for something else, you haven’t realized a gain or loss.
Gains on Crypto Trading are Treated Like Regular Capital Gains
So you’ve realized a profit on a cryptocurrency exchange or trade, such as when performing a profitable buy-and-sell? The Internal Revenue Service (IRS) generally treats these kinds of transactions the same way they would any other kind of capital gain and assesses taxes accordingly.
The tax rates are different for the long-term and short-term. For assets held on to less than a year, you will pay ordinary tax rates. But if you hold the asset for more than a year, then your taxes will be lower–likely at 0%, 15%, or 20%.
The same rules for netting capital gains and losses against each other also apply to cryptocurrencies. You can deduct capital losses up to $3,000 each year. Once you have losses that exceed this amount, you will need to carry them over the next year.
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Crypto Miners May Be Treated Differently From Others
Do you mine cryptocurrency as a business? If so, then you might be able to deduct your expenses. Your revenue is the value of what you produce. If you mine for cryptocurrency, then you make money based on what it is worth in the market. If this is your job, then your expenses may be deductible.
But the key point is that you need to be running a trade or business. You can’t set up your mining rig as something that is just for fun and still has the same tax deductions as someone who runs a real business.
A Gift of Crypto is Treated the Same as Other Gifts
If you are giving someone your cryptocurrency as a present, it will be treated the same way as any other gift. This means that if the present is worth more than $15,000, they would have to pay gift tax (in 2020 or 2021). The gift tax is something you pay when you give someone a gift. You have to pay the tax each year, so that is why there are ways to escape it. One way is by using your lifetime exemption.
Inherited Cryptocurrency is Treated Like Other Inherited Assets
If you inherited cryptocurrency, it is treated like a business or other asset that is passed from one generation to another. It might be subject to taxes if the estate exceeds certain thresholds. But this could change in the future. When people die, the stock they had goes to someone else. It is like that with cryptocurrency too.
They get a cost basis that is higher than what it was worth on the day they died. So for most people, cryptocurrency is treated as a typical capital asset.
It is hard to track cryptocurrencies. It can be difficult to understand how much you paid for it or what your price was worth when you sold it. Plus, the IRS is monitoring people who are trading these currencies because they want to make sure that people pay taxes on them. That is why it is important to understand everything about cryptocurrency taxes.