The last 12 to 24 months have been an exciting time for cryptocurrency enthusiasts. The global crypto market has hit record highs and lows in the past year, and gains and losses have also been hefty for investors around the world. Last 2021 also marked a massive influx of new crypto investors, and that trend doesn’t look to slow down anytime soon as we head into the tail end of 2022.
If you’ve only just gotten into cryptocurrency trading, there’s one major thing you need to be aware of: your cryptocurrency holdings are taxable by the Internal Revenue Service (IRS). This means that yes, you will need to account for certain crypto activities on your next tax return. And while this is a relatively easy process for most crypto users, who generally stick to online exchanges for buying and trading digital currencies, filing cryptocurrency-related taxes is likely to get more complicated for extremely active investors.
Here are a few essential things to take note of regarding crypto and taxation:
The IRS Position on Crypto
The IRS has considered Bitcoin, Ethereum, and other cryptocurrencies taxable since March 2014. However, it treats cryptocurrency holdings as property for US federal income tax purposes, rather than as currency. The IRS thus taxes cryptocurrency in the same way as other more traditional assets, such as gold, stocks, or real estate.
Given the above, how exactly do cryptocurrency taxes work? Cryptocurrencies, like any asset, become taxable when their owner cashes them in or uses them as a mode of payment. Realizing a gain on your crypto, such as when you earn profit from a sale or trade, means you’ll owe taxes on that gain. To understand crypto taxes, then, it’s vital to understand the financial events that will render your cryptocurrencies taxable.
Non-Taxable Events Involving Crypto
Simply buying cryptocurrency with US dollars doesn’t necessarily mean you’ll owe taxes on it by the end of the year. If you’re interested in the cryptocurrency Monero (XMR), for example, purchasing XMR tokens from an exchange and transferring it to your personal XMR wallet isn’t a taxable event by itself. Transferring cryptocurrencies between wallets is also not considered a taxable event.
Other non-taxable events involving crypto include making donations in cryptocurrency to tax-exempt charities or non-profit organizations and, in most cases, gifting cryptocurrency to a third party. Do note, though, that the latter might be subject to gifting exclusions.
Taxable Events Involving Crypto
On the other hand, financial events in which you use your crypto as a method of exchange will trigger taxes. Some examples of taxable events include using cryptocurrency to pay for goods and services, exchanging one type of cryptocurrency for another, and selling cryptocurrency for fiat money. Any crypto you receive as payment for business purposes is also taxable as business income.
Let’s illustrate what a taxable event involving cryptocurrency looks like in more detail. Say you purchase a particular coin at $500 and sell it a few months later at $750. Since you’ve sold an asset held for less than a year, the $250 gain you realized from the sale is taxable at the current short-term capital gains tax rate. If you make the same sale a year or more after the initial crypto purchase, your gain will be taxed according to the long-term capital gains rate.
If you make a purchase with cryptocurrency, you’ll have to pay a sales tax on your purchase. You’ll also need to pay a capital gains tax if your crypto’s value is higher than it was when you initially bought it. In direct contrast to a capital gain, a capital loss is when your cryptocurrency’s value is lower at the time of the transaction than it was when you first bought it. Both capital gains and losses need to be reported at tax time, so make a habit of recording changes in value whenever you use or trade crypto.
How to Manage Crypto-Related Tax Filing
Whether you think of yourself as a hardcore investor or someone who simply dabbles in crypto, planning ahead will make filing your crypto-related taxes easier. Don’t wait until your tax return is nearly due to gather your financial reports from the past year and figure out how much you need to pay. Instead, get used to tracking all your potentially taxable activities and your crypto’s fair market value during those activities. Each month, review your records and ensure that you’re documenting things correctly so you don’t have a hard time figuring out how much tax you owe later on.
Even if your crypto activities are relatively simple, you may want to consider working with a tax professional who has prior experience with virtual currencies. As cryptocurrency is still a fairly young technology, guidance from the IRS and other regulatory bodies is limited and unable to cover every single situation a taxpayer might find themselves in. An experienced tax advisor or accountant who owns virtual currencies themselves should be able to answer your questions and make sure you’re reporting everything correctly.
As cryptocurrency continues to grow, chances are that the IRS and other bodies will continually update their policies on crypto taxation and other regulatory measures. It’s a crypto investor’s responsibility to keep themselves informed and up-to-date on the latest tax guidance for this relatively young and promising asset.
