How does crypto tax work?
Contrary to popular myth, crypto tax applies to cryptocurrency transactions. Discover how the IRS taxes crypto gains and how to report them on your tax return.
Summary
Crypto tax is the tax deducted by the IRS from transactions involving cryptocurrencies.
Cryptocurrency transactions are subject to income tax or capital gains tax, depending on your circumstances.
You are required to report your cryptocurrency gains and losses in your tax return.
It is best to speak to a financial advisor about investing in cryptocurrency and how to comply with crypto tax laws.
What is crypto tax?
The Internal Revenue Service (IRS) imposes tax on citizens’ use of and trade in cryptocurrencies, such as Bitcoin (BTC).
The IRS designates most cryptocurrencies, as well as NFTs, as digital assets. In the IRS’ view, if a particular asset has characteristics of a digital asset, it's treated as one for federal income tax purposes.
Due to this, the IRS may be able to deduct cryptocurrency taxes from any income or profits generated via cryptocurrency transactions.
As you will see, crypto tax is complicated because it can be applied both in the form of income tax and as capital gains tax, depending on certain criteria.
Recently, the IRS designated digital assets as one of its priority areas and hired two former crypto executives to improve its digital currency service, reporting, compliance, and enforcement programs.
When is cryptocurrency taxed?
Simply owning cryptocurrency does not make you liable for crypto tax.
Income and profits generated via cryptocurrency are subject to tax when you use them.
You pay crypto tax in the following instances:
Withdrawals: If you withdraw crypto into traditional currency, such as the dollar, and it is worth more at that time than when you first purchased it, you pay tax. Capital gains tax applies to your effective profit in this case, just as it would in the case of selling shares on the stock market.
Accrued interest: If you sell your crypto or use it in a transaction and, at the time of this transaction, your crypto is worth more than it was when you bought it. Here, you will pay capital gains tax on the positive difference between your crypto's original and subsequent market values.
Business transactions: If you take payment in the form of crypto for business purposes. Crypto tax laws designate such payments as business income, and the IRS taxes them accordingly.
Income: If you mine a certain cryptocurrency or are awarded crypto for work done on a crypto blockchain. This is taxed as ordinary income.
How does crypto tax work?
As the IRS views cryptocurrencies as assets, certain tax events can be triggered by cryptocurrency transactions.
Essentially, when you realize a gain in cryptocurrency, that gain is taxable. Cryptocurrency gains include the sale, exchange, or use of crypto that has increased in value since its initial purpose.
The type of tax due on your cryptocurrency gain depends on your income bracket and the nature of the transaction.
Crypto tax may include capital gains tax and/or income tax.
Some cryptocurrency transactions are also not taxed. These include:
Purchasing a cryptocurrency with cash and simply holding it.
Donating crypto to a qualified tax-exempt charity or non-profit.
Receiving or giving cryptocurrencies as a gift.
Transferring cryptocurrencies between your own wallets.
Are there different types of crypto tax?
Like other virtual assets, such as stocks or bonds, cryptocurrency gains are taxed at different rates as either income or capital gains.
For transactions that incur capital gains tax, how much you pay will depend on the amount, how long you held it, and the capital gains tax rates of your state.
For example, let’s say you bought 1 BTC at $2,000 and sold it at a later date for $7,000, profiting $5,000 in the process:
If the period between the purchase and the resale of your 1 BTC was less than one year, your $5,000 profit is viewed as a short-term capital gain. Short-term capital gains are taxed as ordinary income (between 0% and 37%, depending on your overall income).
If the period between the purchase and resale of your 1 BTC exceeds one year, your $5,000 profit counts as a long-term capital gain and is taxed as such. Long-term capital gains are taxed at 0%, 15%, or 20%, depending on your overall taxable income.
In either case, the sale of your BTC triggered a taxable event.
To ensure that you properly observe crypto tax laws, you must recognize the events that trigger cryptocurrency taxes. To this end, the IRS provides guidelines regarding tax consequences for transactions involving digital assets.
How does crypto tax impact tax reporting?
You'll need to log every crypto transaction you make to enable accurate reporting at the end of the tax year.
This should include the value of your crypto at the time of purchase and its market value at the time of its use or sale.
Fortunately, you don’t have to do this tracking manually, as there are now blockchain platform solutions like CoinTrackr that can do it for you.
Note that all crypto exchanges will be legally required to issue 1099 forms to their clients for the 2023 tax year.
Get expert financial advice
Cryptocurrency counts as a digital asset and may be taxed either as income or capital gains tax, depending on your circumstances.
Despite its potential benefits, cryptocurrency remains a volatile and somewhat unregulated investment option.
As cryptocurrency tax laws are complicated, it is best to consult a financial advisor to help you make the right investment decisions while remaining tax-compliant.
Let Unbiased match you with an SEC-regulated financial advisor to ensure you get the best financial advice for your needs.
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