When it comes to taxes, an IRS report published in 2014 classifies cryptocurrency as property, not currency. Unfortunately, anyone who sells or trades cryptocurrency must pay capital gains taxes on the transaction.
The tax code defines a capital gain as "the excess of the selling price of the property over the adjusted basis." The adjusted basis is calculated by taking the asset's original purchase price plus any improvements made, minus any depreciation.
For cryptocurrency, the purchase price is what you paid for it in U.S. dollars (or the equivalent value in another currency).
If you hold the asset for more than a year before selling it, you must pay long-term capital gains taxes. If you own it for less than a year, you’ll pay short-term capital gains taxes.
In other words, if you profit from selling cryptocurrencies or NFTs, you must pay taxes on those gains.
How Are Capital Gains Tax on Crypto Calculated?
Several factors determine the tax rate you pay on your capital gains. These include the period you hold your cryptocurrency, your filing status, and your income amount.
According to the IRS, the holding period for cryptocurrency begins on the date of purchase, and the holding period ends on the sale date. The timespan is determined by the purchase date, not the sale date. Therefore, it’s essential to remember when you bought your assets.
Short-term Capital Gains on Crypto
For the 2022 reporting year, the federal short-term capital gains rate is similar to your ordinary income tax rate and will depend on your tax bracket.
The lowest federal marginal income tax rate is currently at 10%, while the highest income tax rate is 37%. Your tax bracket, the percentage of taxes taken from your paychecks, is determined by your annual income.
The IRS assumes crypto gains to be an additional source of income and stacked on top of an annual salary. For example, suppose you, a single filer, earned a salary of $100,000 and made an additional $20,000 in short-term crypto investment gains. In this case, your combined taxable income is $120,000.
The IRS breaks income taxes into groupings, where portions of income are taxed differently. The first $9,950 of your income is taxed at the lowest marginal rate of 10%, meaning 10% of $9,950 will be taken out for taxes.
The next $9,951-$40,525 will be taxed at the next bracket of 12%. $40,526-$86,375 will be taxed at 22%, and the remaining $86,376-$164,925, which includes the $20,000 in crypto capital gains, will be taxed at 24%.
Long-term Capital Gains on Crypto
If you hold crypto for more than a year before selling, you will pay long-term capital gains taxes.
For the 2022 reporting year, the long-term capital gains tax rates are 0%, 15%, or 20%, depending on your taxable income and filing status. This rate is lower than the short-term capital gains tax rate because the IRS considers long-term investments to be less risky than short-term investments.
For example, after a year and a half, you and your spouse decide to sell your crypto to reap the financial gains. If you and your spouse file jointly and have a combined income of $200,000, you will only pay 15% in taxes on the gains. This percentage only applies to the crypto capital gains, not the entire yearly income amount.
This is a lower tax rate than if you had sold the crypto after holding it for less than a year, when you would have paid a much higher tax amount.
Taxable Events Using Cryptocurrency
A taxable event is any transaction that could result in paying taxes on gains to the government. The significant instances where a transaction of any kind is considered a taxable event include:
- Selling cryptocurrency
- Trading or exchanging cryptocurrencies
- Purchasing goods or services with crypto
Each mentioned taxable event is held to the same standard where long-term and short-term capital gains taxes apply and are based on an individual’s annual income.
Special Crypto Tax Cases
There are a few exceptional cryptocurrency cases where taxes aren’t withheld or separate tax rules and regulations apply. These situations include:
The IRS considers crypto donations to be the same as cash donations, making them tax-deductible. The current deduction limit for cash donations is 20-60% of your adjusted gross income.
However, you can apply to increase your limit to 100% if you donate long-term capital gains. This means you can deduct the total value of your crypto donation from your taxes. To do this, you need to itemize your deductions on Schedule A of your tax return and keep records of your donation through bank statements or charity receipts.
There is a catch, however. Selling and donating the proceeds from the sale will be seen as a taxable event, and you will be required to pay taxes on your donation. It is impossible to deduct your donation’s total value from your taxes.
Donating crypto directly is often better than selling it and donating the proceeds. By doing this, you can avoid paying sales taxes and deduct a partial or total value of your donation from your taxes.
If you give a crypto gift worth more than $15,000 in a year, you must fill out form 709 and file a gift tax return because the IRS considers crypto gifts as property gifts, not cash.
Unless it exceeds the annual exclusion limit, which is currently $15,000, taxes won’t need to be paid by either party involved – the gifter or recipient.
If you receive a crypto gift and decide to sell it, you will owe taxes on the gains. The tax you owe depends on how long you held the crypto before selling it. Short- and long-term capital gains tax rules will apply in this case.
Inherited crypto is subject to Estate Tax regulations just as any other inherited property, such as real estate or stocks.
The fair market value of the crypto at the time of death is used to calculate the inheritance tax.
For example, let’s say you inherit Bitcoin worth $200,000 from your father. If the fair market value of Bitcoin at the time of death were $20,000, you would owe taxes on the $180,000 gain.
The estate would also have to pay any applicable capital gains taxes on the sale of the Bitcoin if any sale was involved.
Three Methods to Calculate Crypto Gains
Since 2019, the guidelines for calculating crypto capital gains and losses have been relatively straightforward. Three accounting methods can be used to calculate profits, and we’ve provided examples for each below.
First-In-First-Out (FIFO) is the most straightforward method of calculating capital gains. With this method, you sell your assets in the order they were purchased.
For example, let’s say you bought one Bitcoin for $1000 on January 1st, two weeks later bought another Bitcoin for $2000, and then two weeks later bought one more Bitcoin for $1750. You then decided to sell one Bitcoin on March 1st, when it was worth $2500.
With the FIFO method, you would sell the Bitcoin purchased on January 1st since it was the first asset you acquired.
You would have $1500 in capital gains, based on a $2500 selling point minus the $1000 purchase price.
The Last-In-First-Out (LIFO) method is the opposite of FIFO. With this method, you sell your assets in the reverse order you purchased them.
Using the same example above, you would sell the second Bitcoin you purchased on February 1st first since it was the last asset you acquired.
You would have $750 capital gains based on a $2500 selling point minus the $1750 purchasing price. The LIFO method would end up saving you $750 in capital gains.
The third method for calculating crypto gains is the Highest-In-First-Out (HIFO) method. With this method, cryptos purchased at the highest amount would be sold first.
Using the FIFO scenario from above (with $1000, $2000, and $1750 purchasing points respective to the scenarios discussed), the HIFO method would suggest selling the second purchased crypto first. There would only be $500 in capital gains, a $2500 selling point minus the $2000 purchasing price.
Which Method Is Best?
While the HIFO method in the above three examples led to the smallest amount of taxable capital gains, it won’t always work out that way. Investors usually still utilize the FIFO method since it’s considered the most conservative of the three.
Using the LIFO or HIFO methods is only recommended if you’ve maintained detailed records of all crypto transactions, including purchase dates and amounts.
How to Report Cryptocurrency Earnings
Any profit made from crypto, including earnings made from mining crypto, airdrops, selling products, staking rewards, and interest earned from lending, is considered taxable income and needs to be reported as earnings during tax season.
In all the above cases, the value of crypto is based on its USD value at the transaction time.
The IRS has clarified that crypto earnings on taxes need to be reported even if they aren’t cashed out as fiat money.
Any gains or losses from selling, exchanging, or disposing of cryptocurrency are considered capital gains or losses. They must be reported on Form 8949, titled Sales and Other Dispositions of Capital Assets. To fill this form, you must provide the following information:
- Name of the cryptocurrency
- Date acquired
- Date sold or disposed of
- Proceeds from the sale (in USD)
- Cost or other basis (in USD)
- Gains or losses (in USD)
Most exchanges offer a way to download transaction history to find this information. If crypto is held in a wallet, it can be found there. This information will need to be transferred to Form 8949.
Once Form 8949 has been filed, the total capital gains and losses will need to be transferred to a Schedule D, where you report the overall profit or loss for the year.
If there is $10,000 or more in crypto in a foreign bank, or trading application, at any time during the year, a FinCEN Form 114 Cryptocurrency will require filing. This form is used to report foreign financial assets.
Reporting yearly crypto earnings is essential as the IRS has stated that there will be penalties for taxpayers who don’t file crypto gains.
Crypto Capital Gains Taxes FAQs
Filing taxes incorrectly can lead to considerable repercussions. To avoid any issues with the IRS, we’ve compiled a list of frequently asked capital gains taxes questions to help keep you out of any potentially sticky situations.
When Should I Pay Taxes on Crypto?
Taxes should be paid anytime crypto is sold, exchanged, or disposed of. This includes earning crypto as income from mining, selling products and services, or staking rewards.
Is There Tax on Each Crypto Transaction?
No sales tax is added to crypto purchases, only on overall capital gains or losses for the year. Some crypto purchasing applications might add a fee for utilizing their platform, but it is not a sales tax. There might also be an additional filing fee accountants, and professional filers add specifically for having to file crypto capital gains.
Exchanges usually charge a fee for each transaction (mostly 0.1% to 1% per transaction). When you cash out to fiat, there may be additional fees from your bank or payment processor.
Do Cryptocurrencies Have Different Tax Rates?
The tax rates for cryptocurrencies are the same as other investments. Short-term gains are taxed at marginal income tax rates, while long-term gains are taxed at a lower capital gains rate.
Any gains will be taxed upon selling regardless of how long the cryptocurrency was held.
How Do I Keep Track of Crypto Taxes?
The most crucial thing in tracking crypto taxes is ensuring an accurate record of every trade made.
The record should include the trade date, the price at which it was bought or sold, and how many units were traded.
If a cryptocurrency exchange is involved, they may provide a year-end tax report with a breakdown of all the numbers. However, it’s essential to check the accuracy of this report, as exchanges have been known to make mistakes.
It’s also wise to keep personal records if an amended return ever needs to be submitted. The best way to do this is using crypto tax software such as TokenTax or CoinTracker.
Do I Have to Pay Capital Gains Tax when Mining Crypto?
The case of crypto miners is different. Miners use personal computer resources to validate transactions on a blockchain and are rewarded with cryptocurrency for their efforts.
In the U.S., crypto miners are considered self-employed and are subject to business income taxes.
How Can I Avoid Paying Taxes on Crypto?
The only real way to avoid paying cryptocurrency taxes is to hold onto crypto and never sell it. Of course, this goes against the whole point of investing in cryptocurrency: making money.
Another crypto tax strategy you can use is deferring your taxes by investing in a crypto IRA account. An IRA account allows for securely trading cryptocurrencies in a tax-advantaged retirement account with no monthly fees. When you invest in your IRA, your investment lowers your overall taxable income, bringing down your total tax bill while simultaneously preparing you for retirement.
Whether you’re interested in beginning your crypto journey or want to open an IRA account, My Digital Money is here to help. We are a team of crypto financial experts ready to assist you in buying cryptocurrency, opening a crypto IRA, and guiding you through tax season.
Click here to create an account now, or give one of our expert support team members a call at (833) 636-2008 for more information about your options.
We can help you take advantage of the many benefits of investing in cryptocurrencies while minimizing your tax liability.