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Cryptocurrency Tax Explained: A Complete Guide to Crypto Taxes

Taxes will always be around in every financial transaction. Unfortunately, cryptocurrencies aren’t exempted.

The Internal Revenue Service (IRS) considers your Bitcoin and other cryptos as “property,” which means that they are taxable, similar to other assets like gold and stocks. In the new Form 1040, the IRS now asks whether or not you own any virtual currencies, making it difficult to stay ignorant of crypto tax laws.

Failing to pay your taxes can cause you to incur interests and penalties, which adds to how much you initially owe the IRS. In some cases, not paying taxes can lead to criminal prosecution.

Accounting for digital assets in your tax return is relatively easy. You just need to understand how your activity affects your tax liability.

When should you pay taxes on cryptocurrency?

If you only buy cryptocurrencies using U.S. dollars and keep them within the exchange or transfer them to your wallet, it doesn’t mean you’ll owe the IRS tax by the end of the year. Based on Form 1040, you don’t have to report this activity on your return.

However, your taxes may get complicated when you start trading crypto. This includes buying other cryptocurrencies using virtual currencies, selling your Bitcoin for U.S. dollars, or paying for goods or services with crypto. With this, you have to be mindful every time you trade because every move is a taxable event.

How does the IRS tax crypto?

In 2014, the IRS issued a ruling stating that cryptocurrency should be treated as capital assets rather than a form of currency. With capital assets, you’re taxed whenever there’s profit. For example, you purchased $200 of Bitcoin. When it increases in value and sells for $500, you earn $300, subject to capital gains taxes.

What happens if your crypto doesn’t profit but loses value over time? That’s called capital losses, and with it, you won’t owe the IRS taxes. You’ll only owe taxes if you have capital gains. For instance, if you bought $1,000 of Bitcoin and sold it for $700, you won’t get taxed. Plus, you can even use some of your $300 losses to offset other investment gains. 

You can’t deduct all capital losses from your taxable income, as there’s a limit. For individual filers, you can only knock off up to $3,000, and $1,500 if you’re married filing separately.

How much crypto tax do you owe?

Your owed taxes will vary depending on your trading activity and how long you have owned the crypto.

  • If you have owned cryptocurrency for more than a year, your profits are classified as long-term capital gains, which are taxed at a lower rate based on your annual income.
  • If you’ve held your crypto and sold it within a year, your profits are labeled as short-term capital gains, which are taxed at your usual income tax rate.

When you earn virtual currency through mining or receive it as a form of payment or promotion, the entire value of your crypto counts as regular taxable income, and it’s taxed at your usual income tax rate.

Can the IRS track your crypto transactions?

On Nov. 15, 2021, President Joe Biden signed the Infrastructure Investment and Jobs Act (HR 3684). The law mandates brokers of digital assets to report certain information related to crypto trades and payments for tax compliance. It means that exchanges would have to report your crypto transactions to the IRS. Reporting obligations will start on the 2023 tax year (to be filed in 2024).

How do you report crypto income?

When you receive cryptocurrency, whether by earning Bitcoin through mining or accepting crypto from blockchain payments, you need to record its market value in U.S. dollars the moment you receive it. Then, you’ll have to report it as personal income on your tax return.

Keep Good Records of Your Crypto

You don’t have to worry about taxes if you’re just purchasing crypto with U.S. dollars and storing them in your wallet. However, if you’re doing complex crypto activities, you must keep good records of your transactions so that you can accurately report them on your tax return. Even if the IRS has records of your activities from exchanges, it doesn’t hurt to have your own copy and be a responsible crypto trader.