With the expansion of cryptocurrency throughout the globe, more and more investors are diving into the crypto space. Also, as the IRS brings out new tax compliances, it is very easy for investors to get confused. So a clear understanding of crypto taxes becomes all the more important.
Taxability Of Cryptocurrency
In 2014, the Internal Revenue Service (IRS), in their Notice 2014-21, made a decision that Bitcoin and other cryptocurrencies will be treated as an asset similar to ‘property’, rather than currency. This simply means that similar to traditional stocks and assets, even crypto earning will qualify as capital gains and income gains, depending on the activities these digital assets undergo.
What Are Some Of The Taxable Events In The United States?
As mentioned above, some of the activities involving digital assets are considered capital gains, whereas some are considered as income.
Capital Gains Tax
Capital gain tax is the federal fee you pay on the profit that you have earned on an asset whose value has appreciated over the holding period. Profits on cryptocurrency can be earned in the following taxable events:
- Sell cryptocurrency (Bitcoin, Ethereum, Ripple, etc.) for fiat currency (Dollars, Euro, Yen, etc.)
- Trading one crypto for another, either P2P directly or on an exchange
- Purchasing goods and services using cryptocurrency
When an individual earns an income from cryptocurrency. Some of the taxable events under income tax are:
- Receive crypto via airdrops
- Crypto earnings from DeFi lending
- Bug bounties received for carrying out work
- Earnings from stakings and liquidity pools
- Block rewards and transaction fees from crypto mining
How Much Tax Do You Have To Pay?
The next important question is how much tax do you have to pay in a financial year. The answer to this question depends on two factors:
- How long have you held your crypto assets or your holding period?
- Which income tax bracket do you fall under?
The crypto holding period is calculated from the next day of your cryptocurrency assets purchase or you make a cryptocurrency transaction, and it continues till the day you send, sell, trade, or exchange your capital asset. This is what decides whether your gains are short-term or long-term capital gains and losses.
Short-Term Capital Gains
Your crypto assets will be considered as taxable ordinary income if you retain them for a year or less, that is, 365 days or fewer. As a result, this income will be considered a short-term capital gain.
At present, the short-term capital gains tax rate ranges from 10% to 37% depending on the income of the household.
Long-Term Capital Gains
When your crypto assets have been held for more than a year or 366 days, it will qualify as a long-term capital gain.
At present, the long-term capital gains tax rate ranges from 0% to 20% depending on the income of the household.
What If You Incur Losses?
If you incur any loss from selling, trading, or exchanging your crypto assets, you can offset your capital gains with your crypto losses. Since the Internal Revenue Service (IRS) considers cryptocurrency as capital assets, you can deduct up to $3,000 in a year from your ordinary income. Any further losses will be carried forward to the next year. However, if you are married and filing a separate tax return, $1,500 will be deducted from your ordinary income.
In this aspect, it is important to note that you have to report your loss on a specific asset class to be eligible for a capital gains deduction.
The Bottom Line: How To Prepare For The Tax Season?
Now that we have discussed everything about how crypto taxes work, we must understand how to prepare ourselves for the tax season.
Here are some of the important things you need to know when preparing your crypto taxes:
- Record all your crypto activities: You must keep a detailed record of all the crypto transactions you make, including buying, trading, airdrops, and every taxable event as mentioned in the list above.
- Calculate your capital gains and losses: Now that you have a record of all your crypto activities, you can manually calculate your gains and losses, or take the help of a number of services and tax calculators to estimate your taxes.
- Filling your tax documents and forms: There are various tax forms for various types of transactions. For reporting your cryptocurrency capital gains or losses you have to file Form 8949 and attach it to Schedule D form, which is the primary tax form for overall taxes.
For crypto income taxes you must file Schedule 1 Form 1040 and in case of self-employed crypto earning, you must add Schedule C.
- Submit forms and pay taxes: Now that you have calculated and filed all your tax documents, all you need to do is submit these forms and pay your taxes on time, unless you want to file for an extension. In that case, you must file for an extension before October 15, 2021.
Calculation and preparation of crypto taxes can be a complicated process. You can take the help of a number of crypto tax-related services, such as Zenledger, to help you easily calculate your crypto taxes. These crypto-tax services will also help you find options for tax-loss harvesting.
- Should I pay taxes on crypto mining?
Yes, crypto mining is also taxable on the basis of the crypto’s fair market value (FMV) at the time of mining.
- Are crypto donations taxable?
Crypto donations and gifts are non-taxable as per U.S tax laws. However, there are tax implications for donations above $15,000.
- What are the tax rates on short-term and long-term capital gains?
At present, the short-term capital gains tax rate ranges from 10% to 37% and the long-term capital gains tax rate ranges from 0% to 20%, depending on the income of the household.