Cryptocurrency Taxes: How They Work and What Gets Taxed

While cryptocurrency continues to capture investors’ attention with its innovation and potential, one of the most important topics that should not be overlooked is the tax liabilities associated with digital assets.

Cryptocurrency taxation in the United States is a complex process that requires an understanding of several rules and regulations set forth by the Internal Revenue Service (IRS). Whether you’re new to crypto investing or an experienced user, knowing when and how your cryptocurrency is taxed can help you avoid unpleasant surprises and trouble with the law. In this article, we’ll break down the main aspects of cryptocurrency taxation to help you navigate this complex issue.

Is cryptocurrency taxable in the United States?

Cryptocurrencies, despite their decentralized nature and pioneering nature, are no exception to tax laws. In the US, the IRS classifies cryptocurrency as property, which means that any transactions involving these digital assets are taxable in the same way as transactions involving traditional property. This means that any income earned from the use, sale, or receipt of cryptocurrency is subject to crypto tax.

Crypto tax is a tax that is levied on transactions involving cryptocurrency. The main difference between crypto tax and general estate tax is the specificity of the assets themselves and the nature of their use.

Cryptocurrencies can be subject to significant fluctuations in value, and transactions often involve unique scenarios such as mining or use for international payments, which requires a special approach to taxation.
Traditional property, such as real estate or stocks, is taxed under more established and clear rules, whereas the taxation of cryptocurrencies requires a more detailed understanding and consideration of the various factors associated with digital assets.

When is cryptocurrency taxed and when is it not?

In the U.S., cryptocurrency tax depends on exactly what you do with these digital assets. Here’s what’s important to know:

When to pay cryptocurrency tax:

1. Selling cryptocurrency for cash.
   If you sold cryptocurrency and made money on it, get ready to pay tax on the gain.
2. Exchanging one cryptocurrency for another.
   For example, if you exchanged bitcoin for ether and bitcoin has increased in value since you bought it, you’ll have to pay tax on the difference.
3. Buying goods and services with cryptocurrency.
   If you use cryptocurrency for purchases (for example, paying for coffee with bitcoins), the IRS considers it a sale, which means you’ll have to pay tax on that transaction, too.
4. Receiving a paycheck or payment in cryptocurrency.
   If your employer pays you in bitcoins or other cryptocurrency, this is taxed as ordinary income.
5. Mining cryptocurrency.
   If you mine cryptocurrency, you will have to pay income tax based on its market value at the time you receive it.
6. Steakage Rewards.
   Rewards you receive for stealing are also considered income and are taxable.
7. Other types of income.
   This includes various bonuses, gifts, and rewards you may receive from crypto projects – all of which are also taxable.

When you don’t have to pay cryptocurrency tax:

1. Buying and holding cryptocurrency.
   If you simply bought cryptocurrency and hold it until you sell it or use it, you don’t need to pay tax.
2. Cryptocurrency donation.
   If you donate cryptocurrency to a charitable organization, you won’t have to pay tax, and you can even get a tax deduction.
3. Receiving cryptocurrency as a gift:
   If you were given cryptocurrency as a gift, tax is only due when you decide to sell or spend it.
4. Gifting cryptocurrency.
   You can gift cryptocurrency up to a certain amount without paying tax.
5. Transferring cryptocurrency between your wallets.
   If you simply transfer cryptocurrency between your wallets or accounts, there is no tax to pay. It’s not considered a sale or income.

Understanding when you need to pay taxes and when you don’t will help you avoid surprises while filing your tax return.

A few examples of when and how cryptocurrency is taxed:

Let’s look at a few instances where you need to include crypto tax on your tax return:

Buying goods with cryptocurrency

When you purchase any goods or services using cryptocurrency, you are subject to two types of tax liability:

1. Sales tax.
   When you buy something with cryptocurrency, you are liable to pay sales tax. This tax is calculated based on the value of the good or service at the time of purchase, and it is similar to what you would pay if you were using regular money. The seller may include this tax in the total amount you remit.
2. Capital gains tax.
   When you spend cryptocurrency, the IRS treats it as a sale of an asset. If the value of your cryptocurrency has increased since you bought it, you have realized a capital gain, which is taxable. This tax is calculated as the difference between the purchase price of the cryptocurrency and its value at the time of the transaction.

To calculate capital gains tax, you need to:

• Determine the value of the cryptocurrency at the time you purchased it (your basis);
• determine the value of the cryptocurrency at the time of the transaction;
• the difference between these values will be your taxable gain or loss.

Taxation in case of buying crypto

In the case of buying cryptocurrency and then using it to purchase goods or services, taxation is as follows:

Taxation for the buyer.

If you bought bitcoin at a low price, such as $3880 in early 2020, and then used it to buy a car when the value of bitcoin increased to $38,600 in February 2023, you have a capital gain. This gain is taxable.

Calculating the amount of capital gains tax:

• Basis value: $3880 (bitcoin purchase price).
• Fair market value at the time of purchase of the car: $38,600.
• Capital gains: $38,600 – $3880 = $34,720.

This amount of capital gain will be taxable and you will need to pay tax on this difference depending on how long you have owned the cryptocurrency:

• short-term capital gains – if you’ve owned the cryptocurrency for less than a year, the capital gains will be taxed at your regular tax rate;
• long-term capital gains – if you’ve owned cryptocurrency for more than a year, the tax rate will be lower and will be 0%, 15%, or 20% depending on your total income.

Taxation for the seller.

The seller of a car also faces tax obligations:

Gross income.

The seller must recognize the gain on the sale of the car, which is calculated based on the fair market value of bitcoin at the time of the transaction ($38,600).

Capital gain or loss.

The seller must declare capital gain or loss when it exchanges the bitcoin received for fiat money or uses it for other payments.

Peculiarities of taxation in the case of buying crypto:

Taxation occurs only when cryptocurrency is realized (e.g. when it is sold, exchanged, or used to buy something). Simply owning cryptocurrency is not a taxable event.

Tax when cashing out cryptocurrency

When cryptocurrency is cashed out, that is, when it is exchanged for fiat money, the tax liability depends on the capital gains or losses that result from the transaction.

How the tax is calculated:

Determining the basis value.

The basic value of a cryptocurrency is the amount you pay to purchase it, including any fees and commissions. For example, if you bought Bitcoin for $10,000 and paid a $200 commission, your basis value is $10,200.

Determining the fair market value at the time of sale.

The fair market value of a cryptocurrency is the amount you will receive when you sell it. Let’s say your Bitcoin is worth $15,000 at the time of exchange.

Calculation of capital gain or loss.

Capital gain or loss is calculated as the difference between the fair market value of the cryptocurrency at the time of exchange and its underlying value. In our example, this would be $15,000 – $10,200 = $4,800. This amount will be your capital gain.

Taxation peculiarities in the case of cashing out crypto:

If you have a capital gain, as in the above example, you are liable to pay tax on that amount. If the fair market value is lower than the basis, you can claim this loss on your tax return and use it to reduce your taxable income.

Taxation when mining cryptocurrency

When mining cryptocurrency, taxation depends on how you categorize your activity: as a hobby or as a business.

How tax is calculated:

Taxation as ordinary income.

The remuneration received for cryptocurrency mining is taxed as ordinary income. This means that the fair market value of the cryptocurrency at the time you receive the reward will be included in your taxable income for the year.

Mining as part of a business.

If mining is part of your business, the reward is also treated as income, but with deductible expenses. In this case, you can deduct expenses related to mining, such as the cost of equipment, electricity, rental space, and other operating expenses. This will reduce your taxable income.

How tax is assessed when staking cryptocurrency?

When speaking cryptocurrency, taxation involves paying income tax on the rewards received and accounting for capital gains or losses when they are used or converted.
How the tax is assessed:

Income tax on rewards.

Any remuneration received for leakage is subject to income tax as income in the year of receipt. The reward is fixed at the fair market value of the cryptocurrency at the time of receipt.

Statement of Capital Gains or Losses.

If you use or convert the rewards you receive into another cryptocurrency or fiat money, you need to report any capital gains or losses.

Taxation peculiarities in the case of staking crypto:

Any staking rewards are subject to income tax. However, if you don’t convert or use the rewards but simply leave them in your wallet, you can avoid capital gains taxation until a sale or exchange occurs.

Taxes when exchanging cryptocurrencies

When one cryptocurrency is exchanged for another, there are tax liabilities that require capital gains or losses to be recorded.

How the tax is calculated:

• Taxable event.
  The exchange of cryptocurrency is considered a taxable event. When you exchange one cryptocurrency for another, it is effectively equivalent to selling one coin and buying another.

Example: If you exchange 1 BTC purchased for $10,000 for 20 ETH, and at the time of exchange 1 BTC is worth $12,000, you will have a realized capital gain of $2,000.

• Report capital gains or losses.
  You need to report any gains or losses associated with the exchange. To do this, record the price at which you purchased the cryptocurrency (the underlying value) and its market value at the time of the exchange.

Example: If you exchanged 1 ETH purchased for $3,000 and at the time of exchange its value is $3,500, you will have a capital gain of $500 to declare.

Taxation peculiarities in the case of crypto exchange:

Avoiding tax in case of exchange is impossible as any change in the value of cryptocurrency triggers a taxable event. However, if you keep careful records of all transactions and use the services of exchanges that offer the ability to export trade data, you can simplify the reporting process and possibly minimize your tax liability by properly accounting for all losses and gains.

How to do cryptocurrency tax reporting?

If you have cryptocurrency, you’ll have to be a little more organized than those who don’t. When it comes to taxes, it’s important to keep proper records of all transactions so you don’t run into problems. Let’s break down how this works.

Transaction Accounting

Every time you buy or sell something for cryptocurrency, you should record:

• the amount spent, which you used to buy the cryptocurrency;
• the market value of the crypto at the time of the transaction.

You will need this data when filling out your tax returns.

Forms and reporting

When it comes to calculations, it’s important to know about the following forms:

Form 1099.

Brokers and crypto exchanges are required to provide their clients with 1099 forms for the current tax year. These forms contain information about your transactions, making the reporting process easier.

Form 8949.

Gains and losses from cryptocurrency are reported on IRS Form 8949, which is used to report the sale and disposition of fixed assets. When filling out this form, you will need to include:

• the name of the cryptocurrency;
• the date of purchase;
• the date of sale, exchange, or other disposition;
• the proceeds or sale price;
• the underlying value;
• total gain or loss.

This process must be repeated for each taxable event during the year.

Using specialized platforms

There are platforms such as CoinTracker that help you track and organize your cryptocurrency transactions and portfolios. This makes it easier to manage your digital assets and have access to tax information.
If you’re not quite sure how cryptocurrency taxes work, or you just want to make sure you’re doing it right, it’s recommended that you speak to a certified public accountant before filing your tax return, especially if it’s your first time. This will help you avoid mistakes and misunderstandings when calculating your taxes.

FAQ

Is cryptocurrency taxable?

Yes, you are liable to pay taxes on cryptocurrency. The type and amount of taxes you have to pay depends on how you acquired and used your cryptocurrency, as well as your income and tax status.

What is the amount of taxes on crypto?

The amount of cryptocurrency taxes you have to pay depends on your tax status, income level, and the circumstances under which you acquired or used your cryptocurrency. If you pay taxes in the United States, you are likely familiar with how income tax is deducted from your paycheck. Cryptocurrency that you receive as income (such as from mining or staking) is also subject to taxation. These taxes are often not deducted upfront.

When filing your tax return, you must report your income according to the rates applicable to your tax category.

Please note: If you earn a lot from cryptocurrency, it may increase your tax status, resulting in a higher tax rate on some income. For up-to-date federal income tax information, visit IRS.gov.

Summary

Cryptocurrency taxes can be quite confusing as they include income tax and capital gains tax. You may need to pay taxes multiple times in different situations, such as when buying or selling cryptocurrency. To avoid mistakes and calculate your tax liabilities correctly, it is recommended to consult an accountant who understands cryptocurrency and current tax regulations.