Beginning in 2023, cryptocurrency exchanges must report your crypto transactions using IRS Form 1099-B and provide your name, address and gross proceeds from selling digital assets.
Cryptocurrency gains and losses are taxed just like traditional investments such as stocks or mutual funds; depending on how long they were held they are treated as either short-term capital gains or long-term capital gains.
Gains and Losses
Once you’ve purchased, sold, or exchanged digital assets it is crucial that you know exactly which gains and losses occurred in order to report them accurately on your tax return. Gains and losses are calculated based on their cost basis which is the original purchase price of the asset.
Cryptocurrency tax accounting software has recently become widely available, making it easier than ever before to identify your cost basis and calculate capital gains on trades or sales of cryptocurrencies. Unfortunately, many taxpayers struggle with tracking cost basis across wallets and exchanges – something cryptocurrency tax accounting software helps simplify.
IRS guidance indicates that taxpayers should utilise FIFO (first in, first out) accounting when assigning cost bases when selling or disposing of digital assets. This practice is widely utilized within the cryptocurrency sector as it helps identify cost bases quickly and calculate capital gains easily on transactions.
There are also specific accounting methods designed for certain transactions, like converting crypto to USD or exchanging one coin for another one. This accounting method, known as specific ID, may help lower capital gains tax rates if sufficient documentation can be produced to specifically ID all coins involved in an exchange.
Under federal tax law, gains and losses from any crypto or digital asset constitute taxable income under U.S. federal taxes, with this income divided between ordinary income and capital gains.
Ordinary income refers to any form of earnings which do not require capital expenditure such as mining, staking, airdrops and payments for goods or services provided.
When your earnings reach $600 or more in mining, staking, airdrops or token sales, it is imperative that you receive and review Form 1099-MISC so as to ensure accuracy without prompting an audit by the IRS.
Cryptocurrency tax rates depend on several variables, including your taxable events, how much cryptocurrency you own and filing status. For more information about how your tax rate will change in light of these circumstances, reach out to TokenTax’s expert team of advisors.
Cryptocurrency exchanges have quickly become a staple of global economy. They provide an efficient means for trading and purchasing cryptocurrencies while providing secure storage. But these platforms also carry certain tax consequences.
When selling cryptocurrency, any gains must be subject to tax. The IRS views these transactions like any other capital gain or loss and requires you to report all gains and losses on Form 8949.
As a trader, tax-loss harvesting can help you minimize your taxable gains by opting to sell coins at a loss and reduce taxable gains by this strategy.
Or you could hold onto your coins in hopes that they increase in value over time – this can be riskier, but could help avoid taxes on gains in the future.
The IRS considers interest on certain cryptocurrencies such as Bitcoin and Ether to be income, which must be taxed. You may receive crypto interest via centralized platforms like Gemini and BlockFi, or DeFi protocols like Compound.
As cryptocurrency can also serve as collateral, you may also use it to secure a loan and receive it without incurring tax consequences. Usually speaking, loan receipt is not considered an taxable event.
In these transactions, the IRS requires you to identify your payee by their TIN (taxpayer identification number). This enables them to track down illegitimate trading platforms and ensure your money is not being used for illegal activities.
Crypto exchanges must also abide by certain statutory requirements and collect and report customer information such as names, addresses and phone numbers of investors as well as gross proceeds of digital asset sales and capital gains or losses.
Finally, they must implement a Know Your Customer (KYC) process in order to confirm customers’ identities before onboarding them as customers. This procedure may take time; exchanges may need to hire third-party help with this procedure.
IRS and FinCEN have recently conducted investigations into cryptocurrency tax evasion, and may soon require exchanges to report transaction data in 2023. As an investor, you’ll need to comply with this new reporting regime in order to remain compliant and remain within the law.
Taxes on Capital Gains
Your crypto investments could fall under either long-term capital gains or ordinary income taxes, depending on how you file. By holding on for over one year and taking advantage of capital loss carryforwards, avoiding paying the higher long-term capital gains rate and enjoying preferential treatment by the tax authorities.
Any time you purchase or sell crypto, Form 8949 must be filed to report it. Include details such as purchase/sale price and any gain/loss from that transaction. Mining rewards or airdrop coins should also be reported using Schedule C.
Be wary when exchanging cryptocurrency for any currency other than dollars; doing so could result in a taxable event depending on how much was converted and whether its price has decreased since when purchased. Also take note if exchanging one type of crypto for another such as exchanging ETH for ADA.
If you sell any digital assets, any gain or loss on their sale will be taxed as capital gains and this could have an impactful result if your taxable income exceeds certain thresholds.
Specific ID accounting can help lower capital gains tax liability in certain situations, though this requires being managed correctly by an accountant. Since it might not be accessible through crypto tax software, it may be worthwhile to consult a tax expert who specializes in non-fungible token accounting to learn more.
When selling cryptocurrency, if its value drops from when you purchased it, a loss can be claimed to offset any gains. Furthermore, this loss can even be carried forward into future years if your income level allows.
Donating crypto to charity may qualify for tax deductions; just be wary when selecting the date and time for donation.
Taxes on Disposals
As opposed to other forms of property like stocks, cryptocurrency is considered a capital asset by the IRS and thus subject to taxes when sold for profit. Your tax rate depends on how long you owned it prior to selling and your adjusted gross income (AGI).
Short-term gains may be taxed at your ordinary income tax rates, while long-term gains are generally taxed at lower rates than other forms of investment income. Therefore, investing in cryptocurrency transactions through tax-deferred or tax-free accounts like Traditional or Roth IRAs could provide tax savings over time.
Though you aren’t legally required to report the proceeds of your cryptocurrency transactions on your tax return, many exchanges offer transaction reporting similar to what would appear in Form 1099-B and can easily import into tax preparation software.
As with other forms of property, when trading, selling or spending digital currency you should keep track of its cost basis and fair market value each time you do so. This will enable you to accurately calculate any gains or losses from trading activity and can serve as an invaluable aid when filing your tax return.
As well as tracking any temporary losses you incur that are typically not tax-deductible, it’s also essential that you account for any small capital gains made through cryptocurrency trades; otherwise you risk creating an unexpected capital gain and incurring tax consequences as a result of doing so.
When disposing of cryptocurrency assets, the IRS treats them like any other stock or mutual fund purchase – it assigns each transaction a cost basis, which is equal to what was paid initially for these coins.
The IRS will utilize the first-in, first-out (FIFO) accounting method when determining disposals. While typically used for stock transactions, it also works well when accounting for cryptocurrency exchanges due to universal pooling capabilities and easy application of specific identification.
Cryptocurrency mining and staking do not fall under the category of regular income; however, these activities could be subject to the 3.8% Medicare surtax introduced by the Affordable Care Act for any profits generated from mining, staking or airdrops.