Cryptocurrencies Tax Laws in the US
Are cryptocurrencies taxed? And more importantly how are cryptocurrencies taxed?! This is a common question among crypto traders and enthusiasts. If you are reading this, you’re probably looking for answers to this and many other questions about cryptocurrencies and taxes in the US. And already know the basics of cryptocurrency and how to get started. Perhaps you’ve lost money trading crypto assets and are looking for a way to claim these losses and save on your tax bill, or maybe you are using one of those automated trading strategies every month and are now coming to the realization that you have no way of calculating your true tax liability.
History of Cryptocurrency Tax Laws
Cryptocurrency, or digital currency, was supposed to disrupt the concept of financial transactions. But the evolution of ‘virtual’ coins is going quite as planned. With no physical manifestation, no government oversight, and no central bank, digital currencies opened a leeway for some investors to dodge tax authorities and skirt regulation. And for a minute, it seemed to have worked. But the narrative is quickly changing.
In 2014, the Internal Revenue Service (IRS) issued a notice detailing regulations on how taxpayers should report cryptocurrency transactions. Two years later, the IRS summoned Coinbase, a popular cryptocurrency exchange, looking for information about its customers. This was followed by a legal battle between the IRS and the crypto exchange, which Coinbase lost. A court order was issued directing Coinbase to hand over a list of its customers to the tax agency in November 2017.
Sealing the Loopholes
By early 2018, the Tax Cuts and Jobs Act was passed, removing loopholes that allow investors to dodge authorities, and as a result, the government can effectively enforce taxation on cryptocurrencies. This was the real tipping point in the battle to regulate crypto assets. Fast forward one year later, a lot of crypto traders and enthusiasts are wondering how to report taxes on cryptocurrency following the dramatic highs and lows in the crypto markets as well as the outright explosion of digital currencies in the past year.
So, are cryptocurrencies taxed in the US? Yes. If you are a crypto trader or an enthusiast, you’re probably concerned with the process of paying taxes on your trading activity. Many people are generally not familiar with how the IRS deals with cryptocurrencies and other crypto assets. We will delve deeper into the specifics behind reporting your cryptocurrency transactions on your taxes. We will also provide answers for any questions you might have on cryptocurrency tax reporting and how cryptocurrencies are taxed, which will help you report everything legally on your taxes.
What to Know About Cryptocurrencies and Taxes
Now more than ever, it’s important that you pay your cryptocurrency taxes. The IRS is shifting its focus to digital assets as cryptocurrency becomes more mainstream.
When the tax season comes around, cryptocurrency is just like any other asset class.
The problem is that the process of filing cryptocurrency taxes seems too complex that many people end up not doing it. Here are a few things you should know about cryptocurrency taxes this upcoming tax season.
Cryptocurrencies are Treated as a Property
For the purpose of taxes, the IRS generally treats cryptocurrency as property — as opposed to a currency like the US dollar. Even your Stablecoins are not immune, whether they are pegged to US or not. As far as the IRS is concerned, cryptocurrency is an investment property such as bonds and stocks. Therefore, in most cases, digital currency is treated like gold or real estate. This means that whether it’s used for trading/investment or purchasing goods/services, cryptocurrency is subject to short-term and long-term capital gains tax in most situations. We will cover more on capital gain/loss later on the article.
Sales and Trades of Cryptocurrencies Are Taxable
All cryptocurrency trades and sales are taxable. This means that you have to report each and every gain or loss to the IRS. To be more specific, spending cryptocurrency or converting digital currencies to USD as well as exchanging one cryptocurrency to another are taxable transactions. Failure to file your cryptocurrency taxes will have repercussions from the IRS.
Not Every Aspect of Cryptocurrency Is Taxed
You need to trade or sell cryptocurrencies to be subject to taxes. You are not going to be taxed for just buying and holding on to cryptocurrency. For instance, wallet-to-wallet transfers are not taxable. You can move cryptocurrency between wallets and exchanges without realizing capital gains. Also, giving someone cryptocurrency as a gift is not a taxable activity. Lastly, purchasing cryptocurrency with USD is not taxable. Gains are not realized until cryptocurrency is traded, used, or sold.
Types of Cryptocurrency Taxes in the US
There are two major types of cryptocurrency tax in the United States. These are income tax and capital gains tax. If your employer pays you in cryptocurrency, your crypto assets are classified as earnings and subjected to income tax. You pay the same amount of income tax on your crypto earnings as you would in US dollars. According to the Guidance on Virtual Currencies, the IRS treats cryptos as property as opposed to currency. As a result, cryptocurrencies are further subjected to capital gains tax just like other types of investment properties.
Consequences of Not Paying Cryptocurrency Taxes
As stated earlier in the article, failing to pay your cryptocurrency taxes has repercussions. So, what exactly happens if you don’t file cryptocurrency taxes? Avoiding crypto tax, just like any other type of tax fraud, can lead to a maximum fine of $250,000 or a minimum sentence of five years. Following the legal battle between IRS and Coinbase in 2017, the crypto exchange platform is required to release investor information allowing the IRS to increase its focus on cryptocurrency taxes.
How Capital Gains and Losses Affect Your Cryptocurrency Tax
Basically, anything other than purchasing, holding, and transfer of cryptocurrency is a taxable event. This means that you can realize a capital gain/loss at fair market value at the time of the event (when you use, trade, or sell cryptocurrency). Due to a sharp rise in the value and popularity of some cryptocurrencies, individuals stand to make substantial returns by purchasing these crypto assets for investment purposes. It’s imperative to understand how capital gains and capital losses work should your investments grow in value.
A capital gain occurs when you sell crypto assets, such as a digital currency, for more than you spent to purchase it. Capital gain can be short-term or long-term depending on the amount of time you hold onto a crypto asset. Since cryptocurrency gains have recently become a point of interest for the US government, capital gains taxes can add a considerable amount to your tax bill in a single tax year. In the United States, the tax year spans from Jan 1 to Dec 31. All the capital gains realized during this period are weighted against each other and subtracted from the cost basis; your initial investment.
Long-Term and Short-Term Capital Gains Tax
So, how much is capital gains tax on cryptocurrency? It depends on several factors. There are two key variables to consider when calculating your capital gains tax costs: the federal tax rate and state income tax rate. The federal tax rate offers preferential treatment for long-term capital gains. The short-term rate (applies for crypto assets held for less than 365 days) is very similar to the ordinary income tax rate. The long-term rate (crypto assets held for more than 365 days) is roughly half the short-term rate. This can only happen if you hold onto the crypto assets for more than one year.
For instance, if you bought 5 Bitcoins on 17th April 2017 for $1,000 apiece for a total investment of $5000 and sold on March 2018 with the value of the cryptocurrency at $8000 and your new investment now at $40,000, it would be considered a short-term capital gain subject to your ordinary income tax rate. Your capital gains would be subject to preferential, long-term capital gains tax treatment if you held onto crypto assets for more than a year. But things are a bit different when it comes to state income tax.
In states that enforce income tax, all income is subject to the state income tax rate, including capital gains. There’s no preferential treatment for long term capital gains on crypto assets. So, how much is capital gains tax on cryptocurrency? As you can see from the above scenario, the amount of capital gains tax you pay on your cryptocurrency depends on federal and state income tax rates. The amount of time you hold onto your crypto assets also affects how much capital gains tax you pay on cryptocurrency.
Capital Loss Cryptocurrency Tax Laws
Having understood what capital gain is and how it works, you can easily tell that capital loss occurs when the opposite is true. A capital loss occurs when you sell a crypto asset for an amount less than what you spent to buy it. In the case of capital gain, you owe capital gains tax on the dollar amount of the gain. A capital loss means that you lost money trading and you can easily write off your losses since cryptocurrency is treated as a property for the purposes of taxes.
What If You Buy and Hold onto Your Crypto Assets?
What happens if you bought crypto assets and decide to hold on to them? You need to trade or sell cryptocurrencies and other crypto assets to be subject to taxes. You are not going to be taxed for just buying and holding on to cryptocurrency. There are benefits of buying and holding on to crypto assets. Since long-term capital gains are reduced at a long-term rate, the best way to minimize capital gains tax is to buy crypto assets and hold onto them for more than a year.
Losses or gains from exchanging or selling of a crypto asset are taxed as a capital gain or capital loss. Cryptocurrencies used to purchase goods are services are subject to income tax. Digital currencies held as capital assets are treated as property for tax purposes. In this case, your crypto assets are subject to general principles that apply to property transactions. Either way, you must pay taxes applicable to your crypto assets whether you sell or hold onto them.
Do Like-Kind Property Exchange Rules Apply for Cryptocurrencies?
The Internal Revenue Code section 1031 of the United States Internal Revenue Code allows owners of certain types of assets to defer capital gains taxes on any exchange of like-kind properties. This type of transaction is also called a ‘1031 exchange.’ A like-kind property exchange allows an individual to dispose of an asset and acquire a replacement without incurring taxes on capital gains. Both the acquired and relinquished properties must be like-kind and must be held for investment or business purposes.
Do like-kind property rules apply for cryptocurrencies? In other words, can you claim a crypto-to-crypto trade as being of ‘like-kind’ and effectively render a trade a non-taxable event? Well, there’s no clear answer on whether like-kind property exchange rules can be used to defer paying taxes on crypto assets until the assets in question are converted into a fiat currency for 2017 and the years before. A 2018 change to the tax code states that going forward, the like-kind exchange rules only apply to real estate properties until further notice.
How to Report Crypto on Your Taxes
As an American, paying taxes is one of the least enjoyable duties you have to carry out. But you have to do it or the IRS will come knocking, and trust me, you don’t want to be at odds with the tax agency. That’s why you need to do an accurate, transparent reporting of your cryptocurrency taxes this upcoming tax season. Since cryptocurrency tax reporting is a complex undertaking, here’s our guide on how to report crypto on your taxes the right way:
Calculate Your Capital Gains or Capital Losses
Capital Gains/Losses = Fair Market Value – Cost Basis
To calculate your capital gains or losses, you need to determine your cost basis and the fair market value. Cost basis refers to the original value of the assets i.e. how much you paid to acquire the crypto asset, including the price and associated costs such as brokerage commissions and transaction fees. The fair market value refers to the value of your crypto asset at the time you traded or sold it. You will fill out this information on the required documentation.
Here’s an example. Someone buys $100 worth of Bitcoin (price inclusive of transaction and brokerage fees), which equals about 0.01 BTC. A couple of months later, this person trades all his Bitcoins for 0.16 ETH. How does one calculate the capital gains for this crypto-to-crypto trade? The capital gain will depend on the fair market value at the time of the transaction. Assuming a value of $160 for 0.01 BTC, the capital gain is $60 ($160 – 100 = $60). This individual owes the IRS a percentage of the $60.00 in capital gains tax for that coin-to-coin trade.
Obtain the Necessary Documents
After you calculate your capital gains/losses, the next step is to obtain the necessary documentation. You need Form 8949 and 1040 Schedule D to report your capital gains to the IRS. You are required to fill all of your trades in form 8949. You will need all the information you used to calculate capital gains or losses to fill this form. After detailing all your transactions from the calendar year on form 8949, fill out the required information on form 1040 Schedule D. Filling the Schedule D form is the last step to reporting capital gains.
Cryptocurrency Tax Checklist
The process of reporting your cryptocurrency capital gain is no different from that of reporting other types of income tax or capital gains except that you have to compile the information yourself. As a crypto investor, you have to go through the planning, recording of the data, and carry out hundreds of trades every year. There’s a lot of information to compile before the April 15th deadline. In a nutshell, this is what you need to do report your cryptocurrency tax:
- Determine whether you are cryptocurrency miner, someone who gets paid via crypto, or a trader.
- Compile a list complete with all the trades carried out within the tax year. The list must contain the buying price, the selling price, cost of the transaction, net gain or loss, and dates. All these amounts must be calculated in US dollars based on the exchange rate at the time of the trade.
- Submit the information to your accountant or fill 8949 and 1040 Schedule D and any other appropriate forms yourself.
The biggest challenge when it comes to reporting capital gains on cryptocurrency is the sheer volume of the transactions. This is especially true for those who use crypto bots or automated trading strategies to execute trades on their behalf. Every month, these individuals make thousands of trades, and calculating and reporting every single one for tax purposes is practically impossible. However, the emergence of services that can complete these tasks on your behalf has made things easier.
Is There A Way to Avoid Cryptocurrency Taxes?
If you receive cryptocurrency as a gift, it does not trigger income tax. There is no income tax for you, the recipient, or the donor. However, if you transfer or sell (cash out) the crypto assets you received as a gift, then income taxes are triggered. When you cash out by selling the gift you received in the form of cryptocurrency, the market value of the gift on the day the gifting took place determines the taxable value.
Since gifts are technically not subject to income tax, some people try to characterize crypto assets sent to them as gifts when they are not, in which case, the IRS will impose appropriate taxes. A gift has to really be a gift to be exempted from income taxes, so keep that in mind. Tax law is full of cases with people claiming that something was a gift but was still taxed. This is also true for gifts in the form of cryptocurrency.
Unless you can produce documents proving that it was a gift, the tax agency is unlikely to be persuaded. They’ve become more familiar with the gift excuse. Therefore, if you receive a gift in the form of crypto assets, make sure that it’s in the right setting or the IRS will impose an income tax. Are there any ways to cash out cryptocurrency gifts without paying taxes in the US?
Can You Cash Out Without Paying Taxes on Cryptocurrencies?
There are a number of ways to avoid capital gains cryptocurrency taxes in the US. For instance, the ‘like-kind’ exchange rules with regards to cryptocurrencies. In theory, you can use the ‘like-kind’ exception to defer paying cryptocurrency taxes for trades completed before December 31, 2017. Currently, this exception is limited to real estate and crypto traders must pay taxes for coin-to-coin exchanges executed after that date.
Alternatively, you can open an international bank account under an offshore IRA LLC. You can also renounce your US citizenship as a last resort if you don’t want to pay cryptocurrency taxes. A surprisingly high number of people have gone this route. When you cease to be a citizen of the United States, the US government no longer has any rights over your income. Facebook co-founder of Facebook, Eduardo Saverin, and singer Tina Turner are among celebrities who have chosen this option.
Cryptocurrency Tax Laws in the European Union
When it comes to cryptocurrency regulation, European countries have taken a decentralized approach. Crypto tax laws differ from one country to the next. Cryptocurrency sales are exempt from the VAT in all EU countries as well as Liechtenstein and Switzerland. However, Swiss residents are required to pay other types of taxes on their crypto assets including wealth tax, profit tax, and income tax, which comes as a surprise to many given that Switzerland is the land of cryptocurrency.
In Germany, Bitcoin sales are not subjected to capital gains tax. However, German income taxes apply if investments are held for less than one year. A progressive income tax of up to 45 percent is applied in that case.
In the United Kingdom, Bitcoin is treated as a foreign currency. Sales tax is not applicable for cryptocurrencies in Britain. However, cryptocurrency holders must pay capital gains tax on their crypto assets.
