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A Guide to Cryptocurrency Tax Rules

Have questions about cryptocurrency and taxes? Use our guide to better understand how to maximize your cryptocurrency tax strategy.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

Cryptocurrency has taken off over the last few years as a profitable new investment. But, the IRS is not far behind. Tax policies have evolved to include gains and losses made with this digital asset. If you buy, own, trade, or sell any form of cryptocurrency it’s time to start taking notes for your financial planning. 

The cryptocurrency tax rules established by the IRS aim to monitor and regulate the investment type. While these rules are somewhat similar to traditional capital gains taxes, there are certain areas where cryptocurrency stands out. Keep reading to learn exactly when and how to pay tax on cryptocurrency: 

What is the Tax Rate on Cryptocurrency Gains?

The tax rate on cryptocurrency gains is roughly between 10 and 37 percent if the assets were held for less than a year. The tax rate for cryptocurrency assets held for longer than one year is between 0 and 20 percent. As you can see, cryptocurrency gains are taxed according to the short or long-term capital gains taxes.

Cryptocurrency can also be taxed as income under certain circumstances. If you received airdropped tokens, mined cryptocurrency, or were paid for goods or services in cryptocurrency it would be treated as income for tax purposes. In these cases, the assets would be taxed according to your income tax rate. 

How is Crypto Tax Calculated?

Crypto tax is calculated according to how the gains were received or earned, and how long you held the assets for. In the case of short-term gains or cryptocurrency generated as income, your income tax rate will be applied. 

For example, John received payments in cryptocurrency and earned roughly $60,000 in the calendar year. This was his only source of income, and he files his taxes alone. John would be taxed at a 22 percent rate on the cryptocurrency, according to his income tax bracket

Other forms of gains, such as mining cryptocurrency or assets held for over a year, would be taxed differently. Mined crypto incurs the federal self-employment tax rate, which is roughly 15 percent. Crypto held for longer than a year would be taxed as long-term capital gains, which can be calculated according to the amount earned. 

6 Tips for Smart Cryptocurrency Tax Reporting

Cryptocurrency is often taxed as income or capital gains -- an answer that almost sounds too simple to be true. Like most tax-related topics, crypto does get more complicated when you attempt to put these rules into practice. Read the following tips for more context and learn how to bake these rules into your tax strategy: 

1. Report all capital gains and losses (not just when you cash out)

The first thing to know about how to report cryptocurrency tax is that you have to report any gains made, and not just the ones you receive when selling these digital assets. Cryptocurrency is treated similarly to stocks for tax purposes; therefore, you are responsible for reporting gains or losses sustained from a number of practices. 

Not only do you need to report when you sell cryptocurrency for cash, but you need to specify when trading one cryptocurrency for another form of cryptocurrency. The IRS will also be interested in learning whether you have used cryptocurrency as payment or purchased NFTs with cryptocurrency. Essentially the IRS will ask you to report any time you receive, sell, send, or exchange cryptocurrency.

2. Harvest losses year round, instead of annually

Cryptocurrency is known for its highs and lows, and you need to learn how to take advantage of those in order to maximize your tax benefits. While it is most common to harvest tax losses at the end of the year, the volatile nature of crypto demands a different approach. 

Harvest losses throughout the year as crypto experiences market dips. This will help you offset your annual gains and increase your overall tax savings. Additional losses can even be applied to reduce your taxable income for the year. 

3. Report any crypto earned as income

As mentioned above, there are certain instances where cryptocurrency is treated as income. In these cases, crypto would be taxed according to your typical tax bracket rather than being subject to capital gains (though in some cases, capital gains might be lower).

Any mined cryptocurrency, payments received as crypto, or airdropped tokens would be treated as income for tax purposes. You will be responsible for reporting them as such on your taxes. 

4. Understand which crypto activities are NOT taxable

The ownership of cryptocurrency is not treated as a taxable event, and investors would not be responsible for reporting it. If you bought crypto and have not sold or traded it, you will not need to include it when filing your taxes.

Other non-taxable events include transferring cryptocurrency between exchanges, such as moving Bitcoin from one exchange to another; donating crypto, which would even be considered a tax write off; or gifting cryptocurrency, assuming you do not trigger the gift tax rules

5. Pay attention to holding periods

Holding periods are what differentiates short and long-term capital gains, and they can have a big impact when tax season comes around. The IRS generally treats assets held for longer periods more favorably, making the long-term capital gains tax much lower than short-term gains. 

Many investors will advise to hold only long-term capital gains to ensure a lower tax rate when you ultimately decide to sell. This strategy, in combination with strategic loss harvesting, can help minimize your overall tax impact each year. 

6. Leverage capital losses to minimize tax liability

Cryptocurrency is a prime example of using losses to offset gains in the investment world. When executed correctly, harvesting capital losses can minimize your tax liability dramatically. The key is to understand when and how losses can be used in your favor. 

There are rules indicating how you can leverage capital losses. For example, you can only harvest short-term losses against short-term gains; and long-term losses against long-term gains. Take advantage of the tips listed above and harvest losses throughout the year to prepare for tax season. 

Even if you do not realize capital gains within a calendar year, you can still use losses to offset your annual income. Investors can deduct up to $3,000 in losses from annual income, and additional losses can be carried over to future tax years. 

Crypto Reporting 101: How to Pay Tax on Cryptocurrency

As the IRS hones in on new cryptocurrency regulations, it’s important to know how to report and file any gains. If you fail to do so, it could put you at risk of being audited or facing legal consequences. Luckily, the actual filing process is not as complicated as it may seem. Here are the basic steps for reporting and filing taxes with cryptocurrency: 

  1. List out all of your crypto exchanges and transactions from the year, and include any 1099 forms you received

  2. Calculate your capital gains and losses by subtracting the purchase price from the selling price of the assets (selling price - purchase price = capital gain or loss)

  3. Fill out Form 8949, which is the form used to record the sale of any capital assets

  4. Include the totals from on Form 1040 Schedule D, which is the standard reporting form for capital gains and losses

  5. Include remaining losses on your individual income tax return, Form 1040

If you are concerned about any of the above steps, always consult with a financial advisor or tax planning lawyer. As you increase your cryptocurrency portfolio it may be necessary to work with a professional, or, at the very least, use an automated software that assists in calculating your crypto gains and losses. 

Update Your Estate Plan to Include Cryptocurrency Today

Cryptocurrency tax reporting is constantly evolving, especially as the asset type becomes more common. For the time being, crypto is treated relatively similar to other investment types. Most investors will either be responsible for capital gains taxes or income taxes, depending on how the cryptocurrency was obtained. 

As you learn how to fold this investment type into your tax strategy, it is also a good idea to think about including crypto in your Estate Plan. Just like any other asset type, cryptocurrency can be inherited. Including cryptocurrency in your Will allows you to name a beneficiary for your investment, and lets you choose who gains access to your portfolio. Reach out to our team to learn more about incorporating cryptocurrency into your Estate Plan. 

Estimates show that nearly 14 percent of the U.S. population currently owns cryptocurrency -- and that number is only expected to grow. If you are among those who own cryptocurrency, or you are curious about investing, take time to review the cryptocurrency tax tips listed above -- you never know how they might come in handy when tax season comes around.

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