As a crypto investor, it’s essential that you remain aware of potential tax liabilities. The IRS considers crypto property, so those selling or trading crypto are required to report it as income on their taxes.
Sale of cryptocurrency held for more than one year is considered long-term capital gains and subject to lower tax rates than short-term gains.
Mining rewards
Cryptocurrency mining is a complex process requiring special hardware to solve computational problems and generate bitcoins as the result. The IRS views cryptocurrency mining as self-employment activity and taxes miners on their net earnings; as well as taking into account the fair market value of cryptocurrency holdings at the time they are earned – depending on how long these are held, their tax treatment could fall either under short-term capital gains or long-term capital gains rules.
Mining cryptocurrency requires keeping detailed records and paying income taxes on any rewards earned through mining activities, as well as reporting them to the IRS. Consultation with a professional cryptocurrency tax specialist is key in staying abreast of changes in IRS guidance and filing obligations.
Your cryptocurrency mining expenses, including electricity and other energy costs, may qualify for tax deductions. Furthermore, home office deductions may also be possible if you mine cryptocurrency at home; but take care not to overstate these deductions because the IRS could view this as an attempt at tax avoidance on cryptocurrency profits.
Staking rewards are taxed in the same manner as dividends earned on capital investments, with ordinary income taxes due upon receipt and capital gains taxes upon sale – this follows IRS standards on other property derived from investments.
Upon selling cryptocurrency, any increases in value will be subject to capital gains taxes. Long-term gains are taxed as long-term capital gains while short-term gains are taxed as ordinary income – each is treated differently when accounting for taxes.
Airdrops and hard forks
Crypto taxes can be complex, particularly in instances of hard forks and airdrops that create new coins. Such events could significantly expand your portfolio; as a result, it is essential to be mindful of any ramifications for your tax situation.
Hard forks involve the permanent splitting of a blockchain into two distinct versions of its coin. Soft forks may or may not lead to this split, but the general idea remains. Such events often result in new cryptocurrency tokens or coins being issued; existing users of the original coin typically receive some amount of the new cryptocurrency tokens in return.
Revenue Ruling 2019-24, issued by the IRS in October 2019, covers two distinctly cryptocurrency events – hard forks and airdrops. According to this ruling, receipt of new coins due to either hard forks or airdrops are taxable; their fair market value at time of receipt should be reported as such.
To determine this value, the IRS uses a “blockchain explorer,” which uses algorithms to examine cryptocurrency indices and calculate values at any particular moment in time. Furthermore, taxpayers should only recognize their taxable income at the point they receive new coins so they can control, sell, transfer or dispose of them as soon as they take possession.
Criticism of this guidance indicates that it does not take into account how hard forks and airdrops actually function in real life, where it typically takes days or weeks after a hard fork or airdrop for full access to new currency on an exchange; until such time arrives, these coins would likely not be recognized as taxable income by taxpayers.
Donations
Donating cryptocurrency to charitable organizations can lead to tremendous tax advantages. Since the IRS treats cryptocurrency as property, donating appreciated cryptocurrency could enable you to avoid capital gains taxes and deduct its fair market value against your federal income tax bill. But there are certain things to keep in mind when giving cryptocurrency away:
First and foremost, it’s essential to determine the fair market value of any cryptocurrency you donate. You can do this by comparing its selling price on a crypto exchange with that on an established cryptocurrency pricing website. Once this valuation has been established, it must be reported on your tax return.
Keep in mind when donating crypto that substantiation may be required of your donation, such as providing the name and address of the charitable recipient, date, type and value (including fees). For donations exceeding $5,000 it may also require a qualified appraisal report.
Finally, it is essential to keep in mind that charitable contributions of crypto held for over one year may be subject to the same percentage limitations as investments-type contributions, which means your total charitable donation deduction could be limited to 30% or 20% of adjusted gross income – although any unused deductions can be carried forward up to five years later. Before considering making such donations, be sure to seek guidance from an experienced tax professional.
Deductions
No matter whether you purchased cryptocurrency as an investment or as payment, any gains or losses must be reported to the IRS. Cryptocurrency exchanges may issue 1099-MISC forms if they pay more than $600 in rewards or bonuses for activities like trading or mining; earnings from hard forks or airdrops that produce new virtual currencies are considered ordinary income and should also be reported.
When selling cryptocurrency, when calculating capital gains or losses you must subtract your original purchase price (called basis) from the sales price (known as sales price). Long-term capital gains rates differ based on income levels while losses can be offset against other investments up to an annual limit of $3,000.
Maintaining accurate records is vitally important when selling crypto or trading it for other assets, and can prevent an unexpected tax bill at year-end.
Non-fungible tokens (NFTs), an increasingly popular type of cryptocurrency, may incur different taxes depending on how the asset is used. If it is purchased and then used to purchase goods and services, its gain would be considered short-term capital gain; while if held onto for longer and sold for profit later on it would count as long-term capital gain. NFTs may also be subject to the 3.8% Net Investment Income Tax that applies only to higher income taxpayers.
Losses
When crypto investors incur losses on their investment, they are taxed for its lost value upon selling or exchanging it for fiat currency or other assets. Losses must be reported using Form 8949 and 1040 Schedule D.
How much you owe depends on whether or not you are selling or exchanging cryptocurrency for another asset and for how long before doing so. Short-term gains typically incur taxes at a rate equal to your income tax bracket (ranging between 10%-37% depending on bracket) while longer term capital gains have lower tax rates.
Your cryptocurrency investment’s total cost basis can be calculated by subtracting its original purchase price from its current selling price, using either the FIFO (first-in, first-out) or LIFO method to establish it.
As with other investments, crypto losses cannot be deducted on your taxes; however, you can carry forward any unused capital losses in order to offset future gains or reduce other types of income.
Cryptocurrency investments can cause you to incur serious losses, especially if the price falls from its highs. But that does not have to be seen as bad – unrealized losses don’t incur taxes like unrealized gains do; thus if your crypto will continue its decline over time it could be wiser to sell now and claim these losses on your taxes rather than facing a larger tax bill in future years.
