Cryptocurrency has changed the way money works, but new ideas need to be regulated. It is important for both people and businesses to understand how digital assets are taxed. With help from tax lawyers and CPAs who specialize in cryptocurrency, this guide gives you a full picture of crypto taxes.
IRS Cryptocurrency Guide: The Basics
In 2014, the IRS released its first advice on cryptocurrency, calling digital assets “property.” Since then, the regulatory situation has changed a lot, with more audits and stricter enforcement. As digital assets become more common, it’s important to know what your tax responsibilities are.
What Are Digital Assets?
The Internal Revenue Service (IRS) says that digital assets are any digital expression of value that is stored on a distributed ledger that is encrypted and protected in some other way. This includes stablecoins, cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH), and assets that can’t be exchanged for cash.
Importance of Form 1040
Form 1040 now asks taxpayers directly if they have bought or sold digital assets. This change shows that the IRS is paying more attention to crypto taxes. Form 8949 keeps track of cash gains and losses from digital assets. If you answer “Yes,” the IRS will look for it.
Taxable and Non-Taxable Crypto Transactions
Not every crypto transaction is taxed. To escape penalties, it’s important to know the difference between events that are taxed and those that are not.
Non-Taxable Crypto Transactions
Some crypto activities are not considered taxable events, including:
- Buying digital assets with cash.
- Transferring digital assets between wallets you control.
- Gifting cryptocurrency (with some exceptions).
- Donating cryptocurrency to a qualified charity.
Taxable Crypto Transactions
The following activities are considered taxable events:
- Selling digital assets for cash.
- Trading one digital asset for another.
- Using crypto to pay for goods or services.
- Mining or staking crypto.
- Receiving airdropped tokens.
- Getting paid in crypto.
- Receiving interest or yield in crypto.
No matter if you gained or lost money when you sold digital assets, you need to report the sale on your tax return using Form 8949.
Understanding Cost Basis in Cryptocurrency
What is Cost Basis?
Cost basis is the price at which an asset was bought the first time. It is used to figure out whether there were capital gains or loses when the asset is sold. Because assets can move between wallets and exchanges, it can be hard to keep track of prices in the world of cryptocurrencies.
Common Issues with Cost Basis
A lot of people have trouble with “missing cost basis,” especially when assets have been moved between wallets or exchanges. TaxBit and other similar solutions help automate and correctly keep track of costs across many platforms.
Form 8949 and Capital Gains
What is Form 8949?
Form 8949 is used to report the sale or giving away of financial assets, which can include digital assets. It lists the number of units bought, when they were bought and when they were sold, their cost base, and any capital gains or losses.
Short-Term vs. Long-Term Capital Gains
Capital gains are taxed in different ways depending on how long the item was owned:
- Short-term capital gains (assets held for one year or less) are taxed as ordinary income.
- Long-term capital gains (assets held for more than one year) are taxed at reduced rates.
Calculating Crypto Gains and Losses
IRS-Approved Cost Basis Methods
The IRS allows two cost-basis methods for cryptocurrency:
- First-In, First-Out (FIFO): The oldest assets are sold first.
- Specific Identification: You select which specific units to sell to minimize gains or maximize losses.
Choosing a Cost Basis Method
Each method has its own pros. FIFO is easier to understand, but Specific Identification gives you more options for handling gains and loses. Taxpayers can pick the way that works best for them and their finances.
Tax Forms Issued by Cryptocurrency Exchanges
Types of Tax Forms
Cryptocurrency exchanges may issue several types of tax forms, including:
- 1099-MISC: This form reports regular income, such as stake awards or referral bonuses.
- 1099-B: Reports the sale or exchange of capital assets.
- 1099-DA: A new form expected to report digital asset transfers and cost basis.
How Are Crypto Fees Taxed?
Exchange and Network Fees
When you buy, sell, or move crypto, there may be fees that affect your taxes. You can subtract fees paid to buy or sell assets from your capital earnings. But fees for moving money between pockets usually don’t help with taxes.
Crypto Tax Rates Explained
Ordinary Income vs. Capital Gains
- Ordinary income: Includes wages, interest, and crypto payments, taxed at regular income rates.
- Capital gains: Taxed at lower rates if the asset is held for more than a year.
Short-Term vs. Long-Term Capital Gains Rates
Short-term gains are taxed at the same rates as other income. Long-term gains, on the other hand, are taxed at lower rates (0%, 15%, or 20%, based on your income level).
Tax Loss Carry-Forwards and Offsetting Gains
What is a Tax Loss Carry-Forward?
You can carry over capital losses to later tax years if they are greater than your capital gains. In later years, this could lower the amount of income that is taxed.
Strategies for Offsetting Gains
This is called “tax-loss harvesting,” and it lets people use losses to balance out gains. It’s important to match your losses with the right kind of gain (long-term or short-term).
Enforcement of Crypto Taxes
IRS Enforcement
The IRS checks that people are paying their crypto taxes in a number of ways, such as by comparing data from tax forms and exchange records. Penalties and audits can happen if you don’t follow the rules.
Other Considerations for Crypto Taxes
Staking and Mining Rewards
Most of the time, rewards for mining and staking are treated as regular income. But there may be certain rules that must be followed based on the rewards and how they are given out.
Airdrops and Hard Forks
In most cases, airdrops and hard forks are taxable events, and the assets that are given out are taxed as regular income.
Crypto Debit Card Payments
Using cryptocurrency as payment is taxed in the same way that selling the object is. The value of the object at the time it was used is used to figure out capital gains or losses.
Crypto Bankruptcies and Tax Implications
People who lost money in a crypto bankruptcy can get a tax break for it, but only after the amount of any refund is known.
Gifts and Donations of Crypto
Most of the time, gifts and donations are not taxed. Giving crypto to an approved charity, on the other hand, can give you extra tax breaks.
Conclusion
In today’s changing financial world, it’s important to understand and follow crypto tax rules. Using tools like TaxBit and keeping informed can help you make sure you report your taxes correctly, whether you’re an individual investor or a business. Talk to a tax expert at all times to make sure you’re following all the rules.
