As the world of cryptocurrency continues to evolve, navigating the complex landscape of cryptocurrency taxes has become a critical aspect for investors and traders. With the rise in popularity of digital assets like Bitcoin, Ethereum, and others, governments worldwide are grappling with the challenge of regulating and taxing these innovative financial instruments.
In this guide, we’ll delve into the intricacies of cryptocurrency taxes, covering everything from understanding the tax implications to calculating your tax liabilities, reporting gains and losses, determining basis, and strategies for minimizing your tax burden. Whether you’re a seasoned cryptocurrency investor or a newcomer to the world of digital assets, this guide will equip you with the knowledge and tools necessary to navigate the complexities of cryptocurrency taxes with confidence.
Cryptocurrency & Taxes
Cryptocurrencies are treated as property in the United States. This means that any transactions involving cryptocurrencies, such as buying, selling, trading, or using them to purchase goods or services, are considered taxable events.
The tax implications of these transactions depend on various factors, including the nature of the transaction, the holding period, and the specific cryptocurrency involved. Per the IRS, the following activities constitute a taxable event:
- Trading from a cryptocurrency to fiat currency, such as the U.S. dollar (USD)
- Spending virtual currency on goods or services
- Trading one cryptocurrency for another
- Selling coins that were airdropped via a fork
- Earning coins as income
- Mining cryptocurrency
If you purchase and hold your coins, however, you will not have to report or pay any taxes. Transferring cryptocurrency between wallets that you own is also a non-taxable event.
Ordinary Income
If you received virtual currency for services performed, the cryptocurrency is treated the same as other wages. You’ll be subject to income taxes, as well as self-employment taxes if you are a non-employee and received a 1099-NEC. Even if you don’t receive a form from the business that paid you, you will still be required to report the income and pay taxes. Any cryptocurrency you mine must also be included in your taxable income. Crypto income should be reported on Schedule 1, Additional Income and Adjustments to Income, or Schedule C, Profit or Loss From Business, if self-employed.
How to Calculate Your Cryptocurrency Taxes
Calculating cryptocurrency taxes can be a complex and daunting task, especially for those new to the world of digital assets. With the right knowledge and tools, however, you can accurately determine your tax liabilities and stay compliant with the applicable tax laws.
1. Determine Your Cost Basis
Cost basis is the original value of your cryptocurrency at the time of acquisition. For purchased cryptocurrency, your cost basis is the amount you paid, including any fees or commissions. For mined cryptocurrency, your cost basis is the fair market value of the cryptocurrency on the day it was received.
Beginning January 1, 2025, the IRS is requiring all taxpayers to use the wallet-to-wallet method for tracking cost basis. This method requires you to track the cost basis of your digital assets held in each wallet. The previous universal method will no longer be allowed. You’ll have until the new year to allocate any unused cost basis to the assets you hold. This can be done using one of two options:
- Global Allocation (Simple Method): You can allocate your basis to all of your remaining assets using a specific rule.
- Specific Unit Allocation: You can allocate the unused basis across all assets held in a single account. You can also choose to allocate the basis to specific assets held within that account.
Once your allocation is set, you cannot change it. Be sure to keep detailed records of your basis and assets.
2. Calculate Your Capital Gains or Losses
If you hold cryptocurrency as an investment and sell it at a profit, you’ll be subject to capital gains tax. Cryptocurrency held for less than a year before selling will be taxed as ordinary income at your applicable marginal tax rate. If you hold cryptocurrency for more than a year before selling it, any gains will be taxed at the preferential long-term capital gains rate.
When you sell cryptocurrency for less than you purchased it, you can claim a capital loss. This can be used to offset other capital gains or, in some cases, a portion of your ordinary income.
3. Use Cryptocurrency Tax Software or Services
Specialized cryptocurrency tax software and services can greatly simplify the calculation process by automatically tracking your transactions, calculating your gains and losses, and generating the necessary tax forms.
Accurately calculating your cryptocurrency taxes is crucial to avoid potential penalties and legal issues. It’s recommended to consult with a tax professional or utilize reliable cryptocurrency tax software to ensure compliance and minimize your tax liabilities.
Reporting Gains & Losses
Once you’ve calculated your cryptocurrency gains and losses, the next step is to report them on your tax return. You’ll typically report your cryptocurrency gains and losses on Form 8949 (Sales and Other Dispositions of Capital Assets) and Schedule D (Capital Gains and Losses). If you received cryptocurrency as income (e.g., mining, staking, or earning interest), you’ll need to report it on your tax return as ordinary income.
Be sure to keep detailed records of all your cryptocurrency transactions, including the date, amount, value at the time of the transaction, and any associated fees or expenses. You should also keep records of your cost basis calculations, as well as any supporting documentation, such as exchange statements or wallet transaction histories.
Failing to accurately report your cryptocurrency gains and losses can result in penalties, interest charges, and potential legal consequences. It’s crucial to stay informed about the latest tax laws and regulations related to cryptocurrency and to maintain meticulous records to ensure compliance.
Cryptocurrency Tax Planning Tips
Although cryptocurrency transactions are subject to taxation, there are several strategies you can employ to legally minimize your tax liabilities and maximize your returns. Here are some tips to consider:
- Keep Good Records – Use online software or a spreadsheet to track purchases, trades, and sales.
- Pay Attention to Holding Periods – You can save yourself some tax money by waiting at least a year to sell or trade your coins.
- Don’t Forget to Claim Losses – You can take up to $3,000 in cryptocurrency losses if you sold/traded for less than the original purchase price.
- Donate Cryptocurrency to Charity – Donating appreciated cryptocurrency to qualified charitable organizations can potentially eliminate capital gains tax on the donated amount while allowing you to claim a charitable deduction.
- Keep Up With IRS Changes – Be sure to visit the IRS website to stay up-to-date on cryptocurrency tax-related news.
- Work With a Tax Expert – If you’re new to the crypto world, consult with a tax expert to make sure you file all the necessary forms and your calculations are correct.
At Tax Defense Network, we offer affordable tax preparation packages and accounting services. To learn more about our cryptocurrency services, call 855-476-6920 and schedule a free consultation today!