Understanding Cryptocurrency Taxes - Crypto Income Tax Basics
Cryptocurrency taxes in the U.S. is still a major cause of confusion – especially for beginners. If you traded crypto in the past year, you’re likely wondering how it will impact your taxes. This article will explain the basics of cryptocurrency taxation in the U.S. so that you are better informed when contacting a tax professional regarding your crypto activity.
Cryptocurrencies have been all over the news lately, and for good reason! Their value has been surging, leaving many people wondering if they should invest. But while cryptocurrencies are certainly exciting, they also come with a lot of risk.
One thing you need to be aware of is that cryptocurrency taxes are a real thing. Yes, even though these digital assets exist outside of the traditional financial system, you still need to report any gains or losses on your taxes. So if you're thinking about investing in cryptocurrencies, make sure you understand how taxes will play into it. Otherwise, you could end up with a big tax bill next year!
Understanding Cryptocurrency Taxes
As cryptocurrencies become more popular, it's important to understand the tax implications of owning and using them. This guide will help you understand how to report your cryptocurrency transactions on your taxes and what deductions you may be able to claim.
Crypto Tax Basics
Crypto is treated as property for tax purposes in the U.S. Taxpayers are required to report activity like sales, payments, and income to the IRS, and each transaction has its own tax implications.
Any crypto transactions that result in a tax are called taxable events. Some common taxable events include:
● Selling your crypto for cash
● Converting one type of crypto to another
● Getting paid with crypto
● Purchasing goods or services with crypto
● Mining crypto
● Getting crypto from a hard form
● Earning staking rewards
Depending on the tax bracket that you fall under, you’ll be responsible for paying a certain percentage of tax on the capital gains or income you earn from your crypto holdings. Tax rates fluctuate depending on your tax bracket and whether the crypto gain was short or long term.
When do you owe taxes on crypto?
Whenever you incur a taxable event, you are required to report the event in your taxes. Certain circumstances do not trigger a taxable event, such as buying and holding cryptocurrency, transferring crypto between wallets or accounts that you own, donating to a non-profit, or giving and receiving crypto gifts.
Many cryptocurrency beginners choose to purchase and simply hold on to their assets. When you hold crypto, there is no immediate capital gain or loss, so there is no taxable event. Once you “realize” the gains by selling the asset and receiving either money or another type of crypto, you incur tax.
To understand if you owe taxes on your crypto, look at how you used your crypto assets during the prior year. Check the IRS Guidance on Virtual Currency or consult a tax professional if you’re unsure whether your crypto activity incurred a taxable event or not.
How much do you owe?
Estimating how much you’ll owe in taxes can be complicated. To do this, there are some terms to keep in mind:
Fair Market Value
Fair market value refers to how much an asset would sell for on the open market. When it comes to crypto, this is typically the value in USD.
Cost basis is the amount of money you spent to purchase your asset, which includes any additional costs associated with purchase like transaction fees. If you receive crypto from staking or mining, the cost basis is determined by the fair market value of the coin when you received it. However, if you bought crypto, the cost base is typically determined by the price you paid for it.
Gains and Losses
When you sell crypto, you can subtract the cost basis from your sale price (or the fair market value) to determine whether you have a capital gain or capital loss. The amount you pay on any capital gains will depend on how long you held on to your crypto before selling.
Long-term and Short-term Capital Gains
Long-term capital gains refer to any gains you’ve made by selling a crypto asset that you held on to for over a year before selling. Generally, long-term gains are taxed at reduced rates, which vary based on your income. Short-term gains, on the other hand, are taxed at your ordinary income rate, which is typically higher.
Just as with any earned income, income earned from cryptocurrency via payment or mining is subject to income tax. In the U.S., the amount of income tax you pay depends on how much you earn, with high earners paying more.
Income tax also applies when you invest your crypto and have access to unearned interest from platforms like Nexo or BlockFi. Additionally, hard forks, which refer to when a new rule is added to the code and causes the blockchain to diverge, are also treated as income per the IRS.
As you can see, calculating your gains and losses and determining your taxes owed can be challenging. It’s important that you keep records of all your crypto activity so that you can track your cost bases, gains, and losses. Don’t hesitate to reach out to a crypto tax professional to ensure that your taxes are accurate when it comes time to report your hard-earned gains.
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