Since Bitcoin was first introduced in 2009, interest in cryptocurrencies as an investment has slowly but surely gained steam. With this rise in popularity, it has led to increased scrutiny by tax authorities like the Internal Revenue Service (IRS). Because of this, it’s important that investors know the basics regarding filing and paying taxes on their cryptocurrency investments and income.
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How Cryptocurrency Taxes Work
One of the most important things investors need to know before investing in cryptocurrency is how crypto taxes work. Additionally, investors should be aware that classification of cryptocurrencies varies depending on the federal government agency overseeing the investment activity.
The IRS issued guidance in 2014 to help individuals and businesses determine how the government treats cryptocurrency taxes. This notice defined cryptocurrencies as virtual currencies . Despite this name, the IRS stated that cryptocurrencies are not currency for federal tax purposes. Instead, transactions of cryptocurrencies are treated as property, like stocks, bonds, and other capital assets. So, when someone uses, sells, or is paid in a cryptocurrency, they are generally required to pay taxes on it.
Though the IRS treats cryptocurrencies as property for tax purposes, this categorization is not consistent across all federal government agencies.
The Commodity Futures Trading Commission (CFTC), for example, classifies cryptocurrencies as a commodity when regulating a variety of crypto-related trading markets. According to the CFTC , it oversees cryptocurrencies when they are “used in a derivatives contract, or if there is fraud or manipulation involving a virtual currency traded in interstate commerce.” In contrast, the U.S. Securities and Exchange Commission (SEC) can regulate cryptocurrencies as a security and investors can be subject to securities laws.
Do You Have to Pay Taxes on Crypto?
Investors are required to pay capital gain taxes on cryptocurrency when selling, trading, or disposing of their holdings. Additionally, cryptocurrencies can be taxed as income if an individual receives the crypto as a gift, from mining, or for services rendered.
However, not all transactions with cryptocurrencies result in a tax liability. These nontaxable events include buying crypto with cash and holding it, donating it to a qualified charity or non-profit, or transferring crypto to yourself between wallets or accounts.
Situations When You’ll Need to Pay Taxes on Crypto
• Cryptocurrency is sold for cash: When an investor sells cryptocurrency for government-backed currency and makes a profit, the investor will have to pay capital gains taxes on the windfall just as they would on a share of stock.
• Cryptocurrency is used to purchase a good or service: If an individual uses their cryptocurrency to buy a new car or pay for a haircut, they will likely owe capital gains taxes on the purchase. To the IRS, using crypto to buy something is like selling it for cash because the crypto needs to be sold for dollars before it can be used to exchange for a good or service.
• Exchanging cryptocurrencies: When converting or exchanging one crypto for another, it is comparable to selling the one to purchase the other. As a result, the investor may have to pay capital gains tax on the sale of the first crypto if it was sold for a profit.
• Being paid in cryptocurrency: If an individual decides to be paid in cryptocurrency, they will need to pay income taxes on the crypto income depending on their tax bracket just as they would if being paid in dollars.
• Mining cryptocurrency: The proceeds from mining Bitcoin and other cryptocurrencies are typically taxed as income. It’s also possible for the proceeds of some miners to be taxed as business income.
• Crypto is acquired via an “airdrop” or “hard fork”: In the event of a crypto airdrop or hard fork that results in new coins, those new coins are taxed as income.
How Much Do I Owe in Crypto Taxes?
The amount of crypto taxes owed varies depending on an investor’s income, tax filing status, and the length of time that an investor owned a crypto before selling. Additionally, the type of crypto transaction affects what tax rate an individual will be charged. As mentioned above, some situations result in a capital gains tax rate and others an income tax rate.
If an investor owned a cryptocurrency for more than 365 days before selling or using it, the proceeds of the transaction are taxed at the long-term capital gains tax rate. Here are the cryptocurrency tax rates on long-term gains for the 2021 tax year (taxes filed in 2022):
|Long-Term Capital Gains Tax Rates for 2021|
|Tax Rate||Single||Married Filing Jointly||Married Filing Separately||Head of Household|
Source: Internal Revenue Service
If an investor owned a cryptocurrency for less than a year before selling it or using it, the gains are taxed as ordinary income. Additionally, if an individual was paid in crypto, mined crypto, or received crypto via an airdrop, they are taxed as ordinary income. Here are the income tax brackets for the 2021 tax year (taxes filed in 2022):
|Short-Term Capital Gains and Income Tax Rates for 2021|
|Tax Rate||Single||Married Filing Jointly||Married Filing Separately||Head of Household|
Source: Internal Revenue Service
How to File Taxes on Cryptocurrencies
For investors and businesses, the most essential thing to understand is that they are required to report crypto holdings, gains, and losses to the IRS when filing taxes. If a cryptocurrency return is generated — positive or negative — or some type of income is realized from holdings, your crypto will need to be reported to the IRS. This is why it’s important to keep track of any and all crypto transactions.
Here are the basic steps that should be taken when filing taxes on cryptocurrencies.
• Determine what, if anything, is owed. If an investor completed a crypto transaction from the list above, it is likely that it generated a tax liability.
• Record and report transactions. All cryptocurrency transactions will need to be reported on your tax return. Like with stocks and other investments, the IRS requires this paper trail to ensure an individual reports their full tax liability. Generally, a crypto exchange will provide the transaction history for the investor.
• File the correct forms with your tax return. The IRS requires specific forms depending on the activity an individual has conducted with their crypto. That could include making calculations on Form 8949 and then reporting the results on Schedule D of Form 1040 , which outlines and summarizes capital gains or losses.
How to Lower Crypto Tax Liability
If an investor is looking to lower their crypto tax liability, there are several options. Many of the same strategies that are used for traditional investments, like stocks, apply to crypto holdings. Here are a few examples:
Buy and Hold
The buy-and-hold strategy can help investors take advantage of the long-term capital gains tax rate, which is lower than the short-term capital gains tax rate as noted above. When an investor holds on to their crypto for at least one year, their tax rate for the crypto will be lower than if they sold within the first year.
If a loss is realized on a crypto transaction, it can be used to offset the gains made on other holdings. This is called “tax-loss harvesting,” and is a common tactic used to lower tax liabilities on other investments. Investors can use tax-loss harvesting to offset as much as $3,000 in non-investment income.
However, if an investor’s crypto is somehow stolen or lost, they are out of luck and won’t be able to apply the loss against their gains to lower their liability.
The IRS classifies crypto as property, and property donations are tax-deductible and not subject to capital gains taxes.
Here’s how this might work in an investor’s favor: If an investor bought a Bitcoin for $10,000 more than a year ago, and it now has a value of $35,000, they would owe capital gains taxes on that $25,000 gain if they cashed out. But by donating it, they can avoid those capital gains taxes and also take a deduction “generally equal to the fair market value of the virtual currency at the time of the donation if you have held the virtual currency for more than one year,” according to the IRS .
Buy and Sell Cryptocurrency in 401(k) or IRA
Some tax-advantaged retirement accounts like a 401(k) or an IRA are beginning to allow investors to add cryptocurrencies into their portfolios. In these accounts, no annual taxes are assessed on the transactions, since they enjoy tax-free growth. Investors can therefore take advantage of these benefits to trade within the accounts and not be taxed on every transaction. However, depending on the type of account used, an investor may face taxes upon withdrawal.
Recommended: Guide to Bitcoin IRA: Pros, Cons, and What to Know
The IRS is increasing its focus on ensuring that cryptocurrency investors pay taxes. Investors should keep this in mind, remembering that cryptocurrency tax situations are nuanced and complicated. Depending on the circumstances outlined above, cryptocurrency transactions and investments may be taxed as property, like stocks, or as income.
But by keeping track of your crypto holdings and transactions, managing your cryptocurrency tax liabilities shouldn’t be too difficult. As always, you can and should contact a professional if you feel like you’re in over your head.
And if you’re ready to start buying crypto, with SoFi, investors can purchase Bitcoin, Ethereum, Cardano, Tether, Dogecoin, and other cryptocurrencies.
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