Navigating cryptocurrency taxes requires an in-depth knowledge of tax law and reporting requirements. By maintaining accurate records and seeking professional advice, you can reduce your tax burden while capitalizing on investment opportunities.
Cryptocurrency taxes are determined based on events which qualify as taxable activities, including exchange of digital assets for goods or services, mining rewards or staker rewards, gains or losses in value and increases or decreases of value over time.
1. Know What You’re Investing
Cryptocurrency, or cryptocurrency for short, is a digital asset utilizing blockchain technology for secure and decentralized transactions. Although cryptocurrency prices are highly variable and present both investment opportunities and risks, the IRS considers cryptocurrency property and requires all gains or losses to be reported as income on tax returns – this may occur when cryptocurrency is sold for fiat currency, traded on an exchange or used to purchase goods or services.
When selling cryptocurrency for a profit, the IRS taxes you on its fair market value at sale minus its cost basis (the original purchase price). If your position was held over 12 months before being sold off, a lower capital gains rate may apply to you.
Purchase of cryptocurrency using fiat currency or exchanging it for other cryptocurrencies does not generate a taxable event, however using it to purchase goods and services or exchanging it for other cryptocurrencies does. Furthermore, any wages paid using crypto must also be reported on your tax return as income.
2. Keep Track of Your Transactions
Tracking crypto transactions can be difficult, but there are apps and software solutions available that can make this task simpler.
Additionally, you must keep track of when and how you have realized income from your holdings. This could come about through selling them for cash or trading them for units in another cryptocurrency (such as exchanging Bitcoin for Ethereum).
The IRS considers cryptocurrency to be property, so when selling any of your holdings you will need to report any gains or losses on your tax return and provide details such as its fair market value. Mining or airdrops may also generate income; for this reason it’s essential that you keep records of all your transactions and speak to a tax professional so they can assist with identifying which transactions should be reported on.
3. Calculate Your Gains and Losses
Cryptocurrency transactions can trigger taxes in various ways, from buying and selling to exchanging, gifting and spending it on goods and services. In general, the IRS considers cryptocurrency to be considered as a sale of digital assets when traded for fiat currency (such as USD). Therefore you owe capital gains taxes when exchanging crypto for fiat currency such as USD.
To calculate how much taxes owe, subtract your current market value from your original purchase price – this is known as your “cost basis.” Accurate tracking is key for compliance and informed tax strategy, with many tools on the market helping with this task; we advise speaking to an advisor for help in this matter.
Remind yourself that cryptocurrency losses can be carried forward to subsequent years and claimed against any gains, thus lowering your tax bill significantly. This process is known as “tax-loss harvesting”, and can significantly lower your overall tax bill. Furthermore, charitable donations made in cryptocurrency may also be deducted.
4. Talk to a Tax Professional
As the cryptocurrency industry rapidly evolves, tax professionals must remain aware of any regulatory developments. Moore says CPAs can refer to IRS FAQs on virtual currency transactions for guidance; however, such answers may not provide complete coverage.
She notes that one of the greatest challenges in tax is identifying taxable events and transactions. Selling cryptocurrency for fiat currency or using it to purchase goods and services both count as taxable events; mining cryptocurrency, receiving “airdrop” tokens from blockchain projects or receiving “hard forked tokens are also considered taxable events.
Maintaining crypto taxes can be complex, but Gordon stresses the importance of remembering that you are ultimately accountable for reporting all cryptocurrency-related activities. Failing to report these could result in severe penalties and fines; to help ensure compliance, try creating an end-to-end crypto workflow which provides transparency, mitigates risk, and automates data entry into tax software.
