Everything You Need to Know to Comply with Cryptocurrency Tax Rules
Cryptocurrency comes with its own tax rules, but essentially, the IRS treats it similarly to stocks and bonds: as property for tax purposes rather than currency. This means it’s subject to capital gains and losses, and you must report if you’ve held or used cryptocurrency when you file your yearly taxes.
Between capital gains considerations and many other variables, navigating cryptocurrency tax rules may seem daunting at first. Still, with the right knowledge and guidance, you can ensure compliance while optimizing your financial strategies. Whether you’re a seasoned crypto enthusiast or new to digital currencies, our simple breakdown below will equip you to effectively manage your cryptocurrency tax obligations.
When is cryptocurrency taxable?
Taxable events occur when you dispose of cryptocurrency. This includes:
Selling it for fiat currency*
Trading it for another cryptocurrency
Using it to purchase goods or services
Receiving it as compensation
In the first three cases, you’ll owe capital gain taxes if the crypto is worth more than when you purchased it (more on this in the next section). If you receive cryptocurrency as a form of payment for services, it will be taxed as earned income.
*Fiat currency is a currency that a government has declared legal tender, meaning it is officially recognized as a medium of exchange for goods and services within a particular country’s borders. Fiat currencies include the U.S. Dollar (USD) and the euro (EUR).
You do not have to pay cryptocurrency taxes simply for:
Buying it with fiat currency
Donating crypto to a tax-exempt nonprofit
Giving it as a gift to someone (although this could trigger gift tax rules)
Transferring virtual currency from one wallet to another
How do capital gains tie into cryptocurrency?
If you hold cryptocurrency for a year or less before selling or trading it, any resulting profits are subject to short-term capital gains rules and taxed as ordinary income. This can range between 10% and 37%.
However, if you hold your cryptocurrency for more than a year, it is considered long-term and taxed at capital gains rates, which are typically lower than ordinary income tax rates. Long-term capital gains are taxed at 0%, 15%, or 20%, determined by annual income thresholds set by the IRS.
Fortunately, capital gains tax is only triggered once you sell, exchange, or otherwise dispose of your cryptocurrency for fiat currency (e.g., USD) or another asset. Simply buying and holding into your crypto means you generally won’t realize any capital gains, meaning you won’t owe taxes on those unrealized gains.
Can I write off cryptocurrency losses?
Yes, if you sell your cryptocurrency at a loss, you can use that loss to offset your capital gains and potentially reduce your taxable income, subject to IRS limits and rules. This means you can deduct crypto losses against capital gains from investments such as stocks, bonds, or real estate. And if you have more losses than gains, you can use the excess losses to offset earned income.
Keep in mind there are limits on how much capital losses you can deduct in a given year. Currently, the maximum you can write off against ordinary income is $3,000 ($1,500 if married filing separately). You can carry forward any remaining losses beyond that limit to future tax years.
Note that the wash-sale rule for stocks and securities does not currently apply to cryptocurrency. Typically, this rule prevents you from selling an asset at a loss and repurchasing it within 30 days before or after the sale that resulted in the loss. The law covers stocks, bonds, mutual funds, exchange-traded funds, and options. While crypto assets are not yet subject to the rule, this could change soon due to ongoing legislation.
How can I properly record my cryptocurrency records?
As you can see, cryptocurrency taxes are complex—and poor recordkeeping could be a costly tax mistake. Hence why it’s crucial to maintain accurate records of all crypto transactions, including:
Dates
Amounts
Values in USD at the time of each transaction
Purpose of each transaction
This documentation will help you accurately report your cryptocurrency activities on your tax return and offer support if you’re ever selected for an IRS audit.
To make it easier, you can also use a blockchain solution platform, which helps you monitor and organize your records. These platforms offer transparent, accurate tracking, secure storage and access control, and automatic recordkeeping. Some even feature:
Portfolio management tools that allow you to track your cryptocurrency holdings, monitor market prices, and analyze investment performance in real-time
Integration with tax reporting software or built-in tools for calculating and reporting capital gains, losses, and other tax-related information
Integration with crypto exchanges and wallets so you can seamlessly import transaction data and consolidate crypto records in one place
What are the reporting requirements?
When you report your cryptocurrency transactions on your tax return, you must calculate your gains and losses accurately and report them accordingly. First, the current Form 1040 asks, “At any time did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”
According to the IRS, you can select “no” if you only bought cryptocurrency with real currency (e.g., U.S. dollars) but did not sell your digital currency or use it to buy goods or services.
You might receive a Form 1099-K if you made more than $20,000 in payments and 200 transactions in one year. Note that both of these must apply—and you may be one of many who are not using cryptocurrency that frequently.
Either way, you’ll owe taxes on any gains. You’ll typically use Form 8949 to report capital gains and losses and Schedule D to summarize those results on your tax return.
What are the rules for cryptocurrency miners?
Any income generated from cryptocurrency mining is generally treated as ordinary income and subject to income tax. The value of cryptocurrency received from mining is typically included in your gross income for the tax year in which you receive it.
Miners may be able to deduct certain expenses associated with their mining activities, such as electricity costs, mining equipment depreciation, and other operating expenses. These deductions can help offset mining income and reduce taxable income.
Ensure Compliant Cryptocurrency Tax Reporting
Understanding and managing your cryptocurrency tax obligations is crucial to your financial journey in the digital age. By staying informed about the tax implications of your crypto transactions and maintaining accurate records, you can handle the complexities of cryptocurrency taxation with confidence and peace of mind. Although it may take some effort and diligence, it’s integral to staying compliant.
If you have any further questions about cryptocurrency taxes or need personalized assistance, book an intro call with JLS Accounting to learn how we can help today!