The crypto market is booming, and many people are now using cryptocurrencies as an investment. However, the IRS still treats cryptocurrencies as property and not an actual currency.
That means you’ll need to pay crypto taxes, otherwise known as capital gains, if you recognize gains on your crypto holdings.
Cryptocurrency statistics show that millions of Americans bought cryptocurrencies for the first time in 2020, meaning anyone who held through year’s end and into 2021 likely has gains in their trading accounts.
If so, selling them might trigger crypto taxes for you on your tax return.
This blog article will explain the basics of capital gains tax and capital losses in order to prepare you for when the IRS announces their regulation on crypto taxes.
What are Crypto Taxes?
In short, because the IRS ruled in 2014 that cryptocurrencies should be treated as property, they fall subject to the same rules as capital assets.
That means when you sell your cryptocurrencies, you recognize capital gains or losses. When people refer to “crypto taxes,” this is what they mean.
As a result, the IRS requires crypto investors to report sales of cryptocurrency on Form 8949. This is an adjustment summary that reports any capital gains or losses from “proceeds minus cost basis” with your other investment forms (e.g., Schedule D).
The net amount of capital gains or losses get reported on Form 1040.
You will also need to file this form when you sell bitcoins or other cryptocurrencies like Dogecoin and use those proceeds to buy other crypto.
One more thing: when you’re transacting with cryptocurrencies for everyday purchases, these still count as dispositions of property, meaning you fall subject to capital gains on these transactions as well.
Before cryptocurrencies can become truly mainstream and facilitate commerce, the IRS will need to address this problematic treatment as buying groceries shouldn’t trigger a taxable gain on the currency used to make a purchase. Sadly, tax reform didn’t address the issue.
What are Capital Gains?
Capital gains refer to profits made from selling investments at a higher price than what was originally paid to acquire them.
If you sell your cryptocurrency after holding it for less than one year, all profits that were made during this time period would be considered short-term capital gain (STCG), and taxed at your marginal income tax rate.
If you hold your investment longer than a year, the profits are considered long-term capital gains (LTCG). LTCG is still subject to income tax, but will be typically be taxed at a lower rate. Some of the best assets to invest in provide passive income which gets taxed at long-term capital gains rates.
Bitcoin and other crypto assets may not exactly fit the definition of an investment like stocks or bonds because they lack intrinsic value. For IRS purposes though, Bitcoin and its ilk are classified as property, not currency.
This provides an important distinction in terms of crypto tax rates: short-term capital gains taxes are based on the amount gained relative to a taxpayer’s basis (the cost for which an asset was acquired) and taxed at your marginal income tax bracket.
Long-term capital gains taxes– 0%, 15% or 20%, depending on your ordinary income, are imposed for assets that have been held for over a year.
How Can I Trade Cryptocurrencies?
You are able to trade cryptocurrencies in a few different ways. Cryptocurrencies can be traded on exchanges and crypto wallets. You have access through free stock trading platforms and apps like Robinhood, Webull and others.
These apps facilitate trades through cryptocurrency exchanges.
Some of the popular exchanges include Coinbase, Binance, Bitfinex and more. They often require verification before purchasing which can be difficult for some people due to various regulations in different countries on what information needs to be provided by customers during registration.
Cryptocurrency trading is not as straightforward as the traditional stock market and there are a few different ways that it can be done. It’s important to understand what you’re getting into before investing in crypto assets (including non-fungible tokens), because they are volatile and subject to factors beyond your control like hacks or regulatory changes.
It may also make sense for you to hold onto cryptocurrencies by using an apps like Robinhood instead of selling them directly through an exchange. If this applies then it could reduce any capital gains taxes liability should those assets continue their upwards trajectory while waiting for an appropriate time to sell on the upside.
How Can I Track My Crypto Taxes?
If you often buy and sell cryptocurrencies or use them to facilitate your daily commerce, you’ll need a system to track your cryptocurrency activity.
The first step in tracking crypto taxes is to create a spreadsheet. You’ll need to track your gains or losses across all of your trading activity for the year.
This will tell you your cryptocurrency income or loss by calculating your net balance. When you start trading cryptocurrencies on an exchange you’ll need to input all of your trades and their corresponding cost basis information into this spreadsheet. This will tell you how much money you made or lost on each trade.
The total value is found by adding up all your transactions’ net proceeds and subtracting all your transactions’ net cost basis.
If this has a negative number then it means that your trades were unprofitable and had capital loss implications.
If the total has a positive balance, then you’ll need to identify how much of your gains are subject to long-term capital gains taxes and how much are subject to short-term capital gains taxes.
Likewise, you can also use crypto tax software that automatically tracks this information for you on your behalf.
I recommend using ZenLedger.io, which is an easy-to-use and reliable crypto tax software. It offers a great balance of simplicity and sophistication for all your crypto tax needs.
The paid version allows you to set up recurring transactions as well as import data from various sources including Google Sheets or TurboTax files if you have them on hand.
This means that when the time comes for tax day, it will automatically calculate how much money was made or lost on every trade in the past year so there’s no need to do any calculation yourself!
The free version still does everything else such as calculating capital gains taxes owed and generating reports (although these features are less robust and it allows for fewer transactions).