Many people have flocked over to crypto for its long-term potential as an investment. Crypto like Bitcoin has gained strong momentum because people see it as a revolutionary form of payment. In addition, people like the decentralized nature of crypto and thousands of merchants already accept Bitcoin. However, Crypto is an investment and a currency, and this distinction can cause plenty of confusion during tax season. We will discuss some of the ways your crypto gets taxed and some ways to avoid paying crypto capital gains.
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How is Crypto Taxed in the U.S.?
Although cryptocurrencies are decentralized, you still owe taxes to the Internal Revenue Service. The IRS can levy capital gains and income taxes on crypto holders.
Capital Gains Tax
Some investors buy crypto, wait for it to go up, and sell out of their positions. Other investors offload some cryptos to diversify their portfolios and mitigate risk. These transactions can trigger capital gains taxes if your selling price is higher than your cost basis. Cost basis represents the price you paid to acquire crypto. The IRS taxes you on gains based on your income bracket and how long you held onto the position. Holding onto crypto for at least a year before selling will result in a more favorable tax rate.
Some investors sell crypto at a loss to reduce their tax bills. Since the IRS defines crypto as a property instead of a security, it is unaffected by the wash sale rule. You can sell your crypto at a massive loss and immediately repurchase it. The net loss will remain on your records and help lower your tax bill. The wash sale rule applies to stocks. You cannot repurchase the same stock for 30 days if you want your net loss to stand for taxing purposes.
Income Tax
Some employers pay their workers in Bitcoin. You may also receive crypto for referring certain products or playing games that offer crypto. These distributions count towards your income. If you receive $500 in crypto for services, you must report the $500 income. You will owe income taxes on that $500 regardless of how the crypto’s value changes over time. Some people move to states without income taxes to avoid this financial burden.
Taxable Cryptocurrency Events
Cryptos function as assets and currencies. You can buy, hold, and eventually sell this asset. You can also do crypto day trading or give it to a merchant in exchange for goods and services. Knowing how crypto taxes work can help you save money and protect your gains. We will cover some common taxable cryptocurrency events and ways to save money.
Cashing Out Crypto for Fiat
Cashing out of crypto lets you realize capital gains. While securing a profit leaves you with more money than before, it is a taxable event. The IRS will review your transactions and tax you if your transactions yield a net profit. You will have capital gains if you sell at a higher price than your cost basis. Any losses can help you write off taxes and lower your bill.
Purchasing Goods and Services with Crypto
Thousands of merchants accept crypto as a payment method, and some enthusiasts hope crypto will replace fiat currencies in the future. While the decentralized element attracts many investors, using it as a medium of exchange will generate capital gains. Using crypto as a medium of exchange has the same tax result as selling crypto for fiat currency. Instead of selling crypto for a fiat currency, you are selling crypto for a good or service.
The IRS establishes capital gains rates across short-term and long-term assets. If you held onto the asset for over a year, you would get more favorable tax treatment. A low enough income can qualify you for 0% on your long-term capital gains.
Receiving Crypto as Payment
When you receive crypto as payment, it gets treated as income. You have to report crypto income to the IRS. For example, if you receive $500 worth of crypto as payment, you will get taxed on $500. You can’t defer this tax by holding onto the crypto. You will owe income taxes on the $500 regardless of how crypto’s price changes before tax season. It’s similar to investors who make income and immediately put those funds into stocks. Your income taxes don’t change just because your stocks went up or down before tax season.
Mining or Staking Crypto
Proceeds from both of these events get treated as ordinary income. You will have to pay taxes based on the crypto’s value at the time of the transaction.
Invest in over 30 cryptocurrencies from your checking account with no trading fees with the Current mobile app crypto feature.
Titan is an investment platform with a team of experts actively managing your portfolio based on your chosen strategy, including cryptocurrencies.
Alto IRA allows you to invest in stocks, bonds, mutual funds, ETFs, real estate, cryptocurrencies, and even gold for your retirement.
Receiving Crypto in Play-to-earn Games
Cryptocurrencies you receive in play-to-earn games get treated as ordinary income. Earning enough crypto can put you in a higher tax bracket. You should consider crypto’s impact on your taxes as you calculate your budget and save money.
Receiving an Airdrop
You have to report any airdrops as ordinary income. You will get taxed based on your income bracket. You have to report the fair market value of the crypto at the time of receipt. Even if you receive a small airdrop, you must still report it to the IRS.
Is Converting Crypto a Taxable Event?
The IRS treats crypto as property for taxing purposes. It’s an asset some people use like a currency, but the Internal Revenue Service’s viewpoint matters the most from a taxing perspective. Converting crypto into any asset is a taxable event. Even if you convert Bitcoin into Ethereum, you will have to report the Bitcoin sale and pay any necessary capital gains taxes.
Save Taxes When Investing in Crypto
If you sell crypto or use it as a currency, you will come across capital gains taxes. You shouldn’t get intimidated by capital gains taxes. Sometimes, selling and incurring taxes can shield you from depreciation. It’s hard to predict the crypto market, but reducing your taxes is easier. You can use these strategies to cut down on crypto taxes.
Purchase Crypto With USD/Fiat
When you purchase a cryptocurrency with another crypto, you will incur capital gains on the old position. Buying crypto with fiat currencies is a non-taxable event. Therefore, it’s better to hold onto your crypto instead of selling it to buy a different cryptocurrency. If you want to diversify, you can allocate funds from your future paychecks into your next crypto.
Buy Crypto in an IRA
IRAs provide tax advantages for consumers planning and investing for retirement. You can invest with a Roth IRA and never pay taxes on capital gains. There are platforms that let you open a crypto IRA account with only minimal transaction fees and no hidden costs. Crypto has produced generational returns for early investors, and storing your funds in a crypto IRA lets you evade the capital gains taxes.
Hold Crypto
You never have to pay taxes on crypto if you hold onto it. You can let the capital gains grow over time and sell when you are ready. Moving to Puerto Rico or waiting until retirement to sell your crypto can help you escape capital gains taxes.
Transfer Between Your Own Wallets and Exchanges
Transferring crypto from one wallet or exchange to another is not a taxable event since you still own the crypto. Some investors mistakenly sell crypto for cash, move the money into a new platform, and then repurchase crypto. Transferring between wallets and exchanges is less complicated and will not raise your taxes.
Give or Receive Crypto as Gifts (With Limits)
Most crypto gifts are not taxable. The IRS limits how much you can give someone each year ($15,000) and over your lifetime ($11.7 million) without it becoming a taxable event. You should provide the recipient with the purchase date and cost basis. The recipient will need this information for tax purposes if they sell the crypto you give them.
Donate Crypto to a Qualified Nonprofit
Donations do not generate capital gains or losses. You can even get a tax deduction for donating crypto. Some investors donate crypto with low purchase prices to avoid capital gains. Then, they use cash to reacquire the same amount of crypto. If you can donate with crypto or fiat currency, it’s better to donate crypto if you have high capital gains. You have to donate crypto without converting it into fiat currency to avoid capital gains.
