The topic of cryptocurrency taxes is still a cause of confusion, especially to those just entering the crypto space. This guide will introduce you to crypto taxation and show you how to file your returns the right way.
Bitcoin and other cryptocurrencies are continuing to attract significant attention from governments all around the world, and, as a result, tax agencies are ramping up their efforts to make sure individuals and businesses file their tax returns on crypto – and that they do so accurately.
The topic of cryptocurrency taxes is still a cause of confusion, especially to those just entering the crypto space. This article will introduce you to crypto taxation and show you how to file your returns the right way.
Do I Even Have to Pay Taxes on My Crypto?
In 2014, the United States Internal Revenue Service (IRS) issued its first cryptocurrency guidance which identified Bitcoin and other cryptocurrencies as property and not currency. Essentially, this meant that bitcoin would be treated much like other property, such as stocks, bonds, gold, and real estate.
The same principle applies to all other forms of cryptocurrency – ether, litecoin, and the like.
This identification of cryptocurrencies as property means that if you acquire crypto or use it in transactions, the IRS will expect you to file your tax reports on capital gains (losses). You are also obligated to file income tax returns if you receive payments in crypto, for example from mining or when paid in bitcoin.
The IRS’ recent letters to 10,000 individuals regarding their crypto-related tax obligations illustrates that, much like other taxes, failure to report on your trades or income could well constitute tax evasion or fraud.
Demystifying Crypto Tax Terms
Here are some of the key terms related to crypto taxation that you need to know. Knowledge of these terms will help you determine when or if you owe the federal government or state taxes on your bitcoin.
By taxable event, we are referring to any crypto-related actions that result in a tax-reporting requirement. Whenever these “events” occur, you will either have to report capital gain/loss or income tax. Here is what the IRS considers to be taxable events:
- When you trade your crypto for fiat (USD) – for example, withdrawing crypto in fiat from an exchange
- Crypto-to-crypto trades, e.g., when you use bitcoin to buy ether. A capital gain or loss is calculated based on fair market value.
- Using crypto to buy goods or services
- Any earnings/income in cryptocurrency
While these are all taxable events, there are a few types of transactions that do not constitute a taxable event.:
- Using crypto for charity donations or gifts (upto $15,000)
- Transferring or moving your crypto between exchanges
- When you buy crypto using US dollars
Even though these are non-taxable events, capital gains are still realized when you dispose/trade/sell the coins.
A capital asset refers to anything you own. That is, your stocks, bonds, real estate as well as your crypto holdings.
Cost basis refers to the total amount of money used to complete the purchase of any given asset. In crypto, this would be the price for each coin as well as related costs like exchange fees. The calculation of cost-basis can be somewhat tricky depending on where you are based, in the US for ex. You may use methods such as FIFO or LIFO for calculating crypto gains, in Canada you have to use Average Cost Basis. Essentially these are all accounting methods used to determine which coins you are selling.
This refers to any profits or losses you make from the disposal of a capital asset. These are also called realized gains or taxable gains.
Capital Gains Tax on Bitcoin
Does Bitcoin attract capital gains tax? Well, yes, it does. It has since as far back as 2014 when the IRS designated crypto as property. Bitcoin is a capital asset, thus selling or trading it triggers a taxable event which has to be reported.
Note that capital gains can be short term or long term depending on how long you have held them.
Short-Term Capital Gains
Have you held bitcoin or another crypto asset for less than a year? If so, any sale of these assets means you will be paying short-term capital gains tax. The government considers short-term capital gains as something like your regular income, which means the tax rate applicable also applies to other regular income sources.
Following that, what you owe the taxman depends on your tax bracket. If your income is $1000, for example, and you’re liable for a 10% tax rate, then you’ll pay $10. The rates for short-term capital gains rise from 10% for those with $0-$9,525, all the way up to 39.6% for earners whose income bracket is $426,701 per year.
Your crypto tax obligation for short-term gains will, therefore, depend on the bracket in which your crypto income falls.
Long-Term Capital Gains
Some bitcoin investors engage in what we call “hodling”, that is, holding crypto for well over a year. If you do too, long-term capital gains rates apply.
In the US, long-term capital gains rates range from 0% to 20%. This makes Hodling for at-least one year a solid way of reducing your taxable gains.
Income Tax on Cryptocurrencies
Income tax is an annual charge the federal or state government requires of individuals or businesses, calculated based on income. Taxpayers are obligated to report income tax returns yearly.
For cryptocurrency, income tax applies to what you earn as salary or commission. This means you’ll need to file income tax returns if you are a miner or are paid in crypto. Tax will also apply if you invest crypto and have access to unearned sources like interest from platforms such as BlockFi, Nexo etc. Furthermore, the IRS released a new piece of guidance only in October 2019, stating that Hard forks should also be treated as Income.
In the US, Income tax is calculated with a progressive system, which is the same for many countries around the world. This means that the tax you pay will depend on how much you earn, with high earners paying the most.
There is also a variation depending on whether you report as a single filer, married but filing separately or married and filing jointly. It is wise to refer to the 2017 Tax and Job Cuts Act (TCJA) for the specific tax rates.
Figuring Out Your Capital Gains
Capital gain is the difference between the selling price and buying price of an asset. The buying price is referred to as the cost-basis and also includes any associated fees.
Let’s look at an example:
You bought 10 Litecoin (LTC) in December 2017 at $1000. You also paid a fee of 1% on it. Your cost basis would be:
$1010 / 10 = $101 per LTC
Subtract the cost basis from the fair market value (at the time of sale) to arrive at your capital gain/loss. If you sold 1 LTC for $300, then your capital gain is $199. The CGT is paid on this amount depending on holding period and applicable tax rate.
If you have anything more than a handful of transactions this process can become quite cumbersome and time-consuming, luckily there are crypto tax tools out there that can help you generate capital gains reports.
Getting the Filing Right
To file the returns, you need access to relevant IRS forms. You will need Form 8949 and Schedule D 1040. Upon doing so, follow these steps:
- Generate a list of all the crypto trades and sales in the tax year and fill them out on Form 8949. The information should also include data related to each asset’s date of purchase, fair market value, selling or trading date, cost basis, and finally, the calculated capital gain or loss.
- Figure out the total capital gains/losses and enter the amounts onto Schedule D 1040.
- If you received income in cryptocurrencies, declare it on your tax return under ‘other income’.
Once this is done and you have verified the accuracy of the information, complete the filing by sending the form together with other tax returns.
If the whole process still sounds confusing and you can’t wrap your head around it, you may consult a crypto tax professional or a CPA who specializes in cryptocurrencies. Either way, the bottom line is that it is best to keep taxes in mind when trading cryptocurrencies if you want to keep your hard earned gains. Don’t fall in the trap of tax avoidance as it is a costly endeavour.
Robin Singh is the co-founder and CEO of Koinly.io – a cryptocurrency accountancy and tax reporting platform that automatically generates capital gains reports for USA, UK, Australia, Ireland and other countries.