What You Need To Know About Crypto And Taxes
Crypto tax laws themselves arent actually that complicated.
Like other assetssuch as gold, stocks, or bondsthe IRS classifies crypto as property. As a result, you dont pay taxes on Bitcoin until you sell or trade it.
Reporting crypto earnings on your taxes, on the other hand, can be confusing and time-consuming. For starters, youll need to fill out several tax formsincluding the 1040, Form Schedule D, and Form 8949, to name a few. This includes reporting every sale or trade, the amount you originally paid, the sale price, and the date of the sale.
To make things more difficult, while many crypto exchanges allow you to download transaction records as an Excel or CSV file, not all are so helpful. Some, for example, only provide your transactions for the last month or quarterif at all.
Whatever the case, the burden is on you to correctly report each and every taxable event. This includes:
- Sales of crypto
- Exchanges for USD or other currencies
- Purchases using crypto
Additionally, if you are participating in decentralized finance yield farming or staking and earn tokens as a result, your earnings are subject to taxation as income.
Irs Considers Crypto As Property
Cryptocurrency is subjected to taxes overseen by the Internal Revenue Service . The Internal Revenue Service issued Notice 2014-21 in 2014 that stated cryptocurrency is considered âpropertyâ and not currency.
Simply put, cryptocurrency is treated the same as stocks, bonds, and other assets that qualify for capital gains taxes. There are also instances where crypto is treated as income and thus qualifies for income taxes.
Letâs understand this concept with an example. Kate bought $20,000 of Ethereum in August 2021 and sold it in October 2021 for $25,000, Kate would realize $5,000 as a capital gain.
On this capital gain, the amount of tax that must be paid by Kate is dependent on the tax bracket and the holding period .
But what if Kate hadnât bought the crypto ?
If she had received cryptocurrency through mining, airdrops, or as interest from lending, her income would then be subject to income taxes, the rate of which would depend on the income slab she comes under.
Now, the next question that could come to mind is – how will the tax be calculated? For this calculation, it is crucial to understand three essential concepts:
- Fair market value
- Cost basis
How To Determine If You Owe Crypto Taxes
You owe crypto taxes if you use your crypto in any way and it has increased in value from when you first bought it.
Here are the different types of taxable events for cryptocurrency transactions:
- Selling cryptocurrency for a fiat currency
- Using cryptocurrency to purchase goods or services
- Trading different types of cryptocurrency
These are only taxable events if the value of your crypto has gone up. To determine if you owe crypto taxes, you need the cost basis, which is the total amount you paid to acquire your crypto. Then you compare that to the sales price or proceeds when you used the crypto.
Let’s say you previously bought one bitcoin for $20,000. Here are examples of taxable events:
- If you sell one bitcoin for $50,000, you’d report $30,000 in gains.
- If you use one bitcoin to purchase a $45,000 car, you’d report $25,000 in gains.
- If you trade one bitcoin for $50,000 of another cryptocurrency, you’d report $30,000 in gains.
Trades between coins are where crypto taxes get complicated. A crypto trade is a taxable event. If you trade one cryptocurrency for another, you’re required to report any gains in U.S. dollars on your tax return.
Every time you trade cryptocurrencies, you need to keep track of how much you gained or lost in U.S. dollars. That way you can accurately report your crypto gains or losses. If you’d rather keep it simple, cryptocurrency stocks could make it easier to track gains and losses compared to buying and selling specific coins.
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Australia’s Leading Crypto Accountants In Wyoming
If you are actually willing to move to Puerto Rico, there are some great services out there that make the process pretty seamless, such as relocatepuertorico. com. PRelocate makes it simple to move to Puerto Rico and pay 0% on your capital gains. What is Cryptocurrency accounting software? Crypto tax software is pretty simple – instead of having to calculate all the taxes you owe on all your trades or crypto income, you can input your data into crypto tax software and it will generate what you owe.
It will also hand that information over to your regular tax software, like turbotax. If you make lots of trades, most crypto tax software will connect to your exchange accounts and import the data for you. How does cryptocurrency taxes work? If you have ever paid taxes on real estate or any other hard asset, then crypto works the same way.
That means you pay taxes on the difference between the price you bought the coins and and the price you sell them at. This is true whether you live in Canada, the US, or the UK, as well as many other countries. Do I still pay taxes if I only made losses on my cryptocurrency? You must report both profits AND losses.
Can Losses Due To Crypto Exchange Hack / Scam Be Deducted
Losses that have occurred due to theft/hacks are no longer deductible as of tax year 2017.
There is a special case that allows such deductions but only if the theft/hack is attributable to a federally declared disaster which is unlikely to ever be the case with exchange hacks. Losses that occurred prior to 2017 may be deductible as long as you can prove ownership of the assets and can provide a declaration or receipt of some kind from the exchange which specifies how much you lost in the hack.
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How Are Hard Forks Taxed
If a certain cryptocurrency that you are holding goes through a hard fork which âoccurs when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger,â the new forked cryptocurrency you receive is taxed as income.
Your cost basis in the newly received cryptocurrency becomes the income you recognize.
Megan held 2.5 Bitcoin in July of 2017 and received 2.5 Bitcoin Cash as a result of the bitcoin cash hard fork.
Megan recognizes income at the fair market value of the bitcoin cash at the time it was received. If Bitcoin Cash was trading for $500/BCH that day, Megan would recognize income of $1,250 . Meganâs cost basis in this Bitcoin Cash becomes $1,250.
Give Up Us Citizenship
For most US citizens this is something unheard of. Its not much of a workaround the tax system, but an actual runaway. The method is quite drastic, but there are many that consider the IRS stance on cryptos to be exactly the same. For example, any US citizen is required to pay US tax on their capital gains regardless of where they live.
It goes without saying that once a US citizenship is renounced, the IRS no longer has any rights over that persons income. If youre really considering this option, then please note that you may be required to pay an exit tax. Furthermore, you will also need a second passport. As far as options for a second passport are concerned here are the most popular ones: you can buy one from countries like Malta, Dominica, or St. Lucia, or you can earn one by becoming a resident of a foreign country if youre not already.
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A Gift Of Crypto Is Treated The Same As Other Gifts
If youve given cryptocurrency to someone, perhaps a younger relative as a way to spark interest, your gift will be treated the same way as any similar gift would be. So it can be subject to the gift tax if its over $15,000 . And if it comes time for the recipient to sell the gift, the cost basis remains the same as the givers cost basis.
That said, there are some ways to escape the gift tax, even if you go over the annual threshold, such as taking advantage of the lifetime exemption.
Remember You Are Required To Claim Your Crypto Losses On Your Taxes
Failing to report your losses and gains could have big consequences, said Kevin F. Sweeny, a former federal tax prosecutor. Because many exchanges have failed to issue 1099-B tax forms that report cost basis information, the IRS oftentimes does not know whether a taxpayer had net taxable gains or losses for the year. The IRS is therefore auditing any taxpayers who traded cryptocurrency, but failed to file an IRS 8949 capital gains and loss report.
The IRS has been clear in its intent to crackdown on unreported crypto gains and losses and is going after non-compliant taxpayers. The IRS has now created a dedicated virtual currency team to trace the blockchain and find non-compliant taxpayers. The IRS searches the blockchain using technologies developed by companies such as Chainalysis to identify taxpayers who traded cryptocurrency. If the taxpayers failed to file an IRS 8949, then they are an easy target for an IRS audit. You should therefore file your cryptocurrency taxes regardless of whether you had gains or losses in order to avoid an IRS audit.
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How To Minimize Crypto Taxes
Now that you know a bit more about crypto taxes, which is really just another way of saying capital gains taxes, you will want a set of strategies to minimize how much you pay to the IRS. Here are some useful tips to reduce your tax bill.
1. Hold Until Your Short-Term Gains Turn Into Long-Term Gains
As just noted, different capital gains rates will apply depending on how long you own cryptocurrency. If you want to lower your tax bill, hold your cryptocurrency long enough to turn your short-term gains into long-term gains. It may not be an easy task, but if you have the patience and fortitude to keep your crypto for at least a year before selling, then youll likely pay a reduced tax rate on any capital gain.
Heres an example: Mary, a single taxpayer, earns $70,000 in wages for 2021. She also has $5,000 in capital gains from the sale of cryptocurrency. If the gain is short-term gain, shell have $75,000 of ordinary income. After claiming the standard deduction, that leaves her with $62,450 of taxable income, which puts her in the 22% tax bracket and results in a tax bill of $9,488. However, if the gain is long-term gain, the $70,000 of ordinary income, minus the standard deduction, is still taxed in the 22% bracket, but the $5,000 of capital gain income is only taxed at 15%. That means an overall tax of $9,138 and a savings of $350.
2. Offset Capital Gains with Capital Losses
3. Sell In a Low-Income Year
Can I Invest In Crypto Tax
Canadian residents can take advantage of the Tax-Free Savings Account . Any profits made within that account are tax-free. While you cant buy cryptocurrency directly in your TFSA, you can buy a Bitcoin Exchange Traded Fund in your TFSA. These ETFs track the price of Bitcoin and they are aimed at individuals who wish to invest in Bitcoin without having to deal with exchanges, wallets, and all the technical aspects. They are the easiest way to invest in Bitcoin, but they also have high management fees and you wont actually own the coins yourself. These are the ETFs that trade on the Toronto Stock Exchange that you can buy using Canadian dollars:
- Purpose Bitcoin ETF
- CI Galaxy Bitcoin ETF
You can easily purchase shares in these ETFs with either Wealthsimple or Questrade.
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Capital Gain & Loss On Crypto
A capital gain or loss is incurred on trading or selling cryptocurrency. Just like traditional assets, capital gains will be incurred when the price of selling is greater than the price it has been acquired for . On the other hand, a capital loss is incurred when the price of selling is lesser than the price it was acquired for.
Before selling a capital asset, you must figure out if the investment was short-term or long-term. Long-term gains and losses are incurred when the assets were held for more than a year, whereas short-term capital gains and losses are incurred when the assets have been held for less than one year.
Reporting Crypto Ordinary Income
Unfortunately, ordinary income doesnât fall nicely onto one tax form like we saw with capital gains and Form 8949.
The ordinary income you receive from mining, staking, interest accounts, or perhaps crypto you received as payment from a job get reported on different tax forms, depending on the specific situation.
Schedule C – If you earned crypto as a business entity, like receiving payments for a job or running a cryptocurrency mining operation, this is often treated as self-employment income and is reported on Schedule C.
Schedule B – If you earned staking income or interest rewards from lending out your crypto, this income is generally reported on Schedule B.
Schedule 1 – If you earned crypto from airdrops, forks, or other crypto wages and hobby income, this is generally reported on Schedule 1 as other income.
To make things easier for investors, CryptoTrader.Tax generates a complete income report that is included with your completed crypto tax reports. This report details the US Dollar value of all of your cryptocurrency income events that you received throughout the year: mining, staking, airdrops, and more. This income report can be used to complete your relevant ordinary income tax forms like Schedule 1, Schedule B, and Schedule C.
For a step-by-step walkthrough of the crypto tax reporting process, checkout our explainer video below.
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What Is Virtual Currency
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like real currency , but it does not have legal tender status in the U.S. Cryptocurrency is a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.
Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as convertible virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.
How To Invest In Crypto Tax
Roth IRAs have been attracting a lot of media attention lately. While these reports have prompted questions about wealthy investors using Roth IRAs as tax shelters of sorts, companies like Alto are helping ordinary investors realize the true potential of these retirement plans.
Why are so many wealthy investors housing massive investments within Roth IRAs? Unlike traditional IRAs, which well discuss in a moment, investments in Roth IRAs are not tax deductible. Instead, they offer a potentially greater benefit: Roth IRAs allow your investment to grow completely tax-free, so long as you wait until six months after turning 59 to make your first withdrawal and youve had a Roth account for at least five years. Not to mention, there is no requirement to begin taking minimum distributions at age 72, as with other IRAs.
When it comes to crypto, this is huge. No matter how many times you sell or trade crypto, or how much your investments grow, you wont pay a dime in taxeseither in capital gains or when you go to withdraw. Even if you had invested $1,000 in Bitcoin in 2011the equivalent of around $3 million todayhad you done so within a Roth IRA, you would owe nothing in taxes.
So with tax-free withdrawals, why would anyone invest in a traditional IRA?
Roth IRA Contribution Limits Explained
In 2021, individuals whose modified adjusted gross income is $140,000 or more are ineligible to contribute to a Roth IRA.
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Offset Capital Gains With Your Cryptocurrency Losses
As mentioned earlier, cryptocurrency losses can be used to offset capital gains and lessen your tax burden. In fact, savvy crypto traders often sell assets at a loss intentionally to offset capital gains with a strategy called crypto tax-loss harvesting.
When offsetting your capital gains with losses, pay attention to the holding period of the assets. You are only allowed to offset long-term capital losses against long-term capital gains and short-term capital losses against short-term capital gains. Once youve offset losses of the same type, you can then use either long-term or short-term capital losses against short-term capital gains.
What You Have To Report On Your Tax Return
The IRS considers cryptocurrenciesand there are many, not just Bitcoinas a type of virtual currency. However, it taxes these virtual currencies as property. In general, you want to remember that:
- You may need to report your gains if you sold a cryptocurrency, exchanged cryptocurrencies or used cryptocurrency to purchase goods or services.
- You can deduct your losses if you sold or spent cryptocurrency that lost value.
- You can take a charitable contribution deduction if you donate your cryptocurrency to an eligible nonprofit.
- The Form 1040 now asks whether you’ve received, sold, sent, exchanged or otherwise acquired a virtual currency. However, you don’t need to answer yes if the only transactions were purchases of virtual currency with real currency.
To determine how much you’ll need to report in gains or losses, you first need to know the value of the cryptocurrency in U.S. dollars when you first bought or acquired it. The value, inclusive of any fees you paid, is known as your cost basis. You’ll compare this to the price when you sell or spend it to figure out your tax liability.
For example, if you bought a Bitcoin for $10,000 after fees and sold it for $15,000, you had $5,000 in gainsthat’s what you’ll pay taxes on. These gains will be reported on Form 8949 and summarized on Schedule D in your tax return.
The IRS offers further clarification on virtual currencies in an FAQ that it periodically updates.
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