Cryptocurrency and Tax Implications
The whole world is watching as Bitcoin and the rest of the cryptocurrency market keep notching new record highs.
A cryptocurrency is a decentralized, digital store of value and medium of exchange. It’s not a currency with any physical tokens, like dollar bills, and it lacks any centralized governmental oversight.
Instead, cryptocurrency relies on encrypted, distributed ledgers—so-called blockchain technology—to record and verify all transactions. Think of blockchain ledgers as a constantly updated checkbook that tracks every single transaction ever made in a given cryptocurrency.
Bitcoin was the first cryptocurrency, launched in 2009. Today there are thousands in circulation, including Bitcoin Cash, Litecoin, Ripple and Dogecoin.
As the value of Bitcoin (BTC) temporarily surpassed the $60,000 threshold earlier this year, and Ethereum (ETH) has quadrupled in value since the beginning of 2021, the Internal Revenue Service (IRS) is watching these trends, too. If you own cryptocurrency, like Bitcoin or Ethereum, you need to understand how it impacts your tax liability every time you buy it, sell it or mine it.
There’s one aspect of crypto investing that hardly anyone is talking about — the tax implications and a lot of crypto investors have no idea what they’re doing. Crypto taxes are based on a 2014 IRS ruling that determined cryptocurrency should be treated as a capital asset, just like real estate, rather than a currency.
This decision has major ramifications for people who own crypto, as it opens them up to more complicated taxes. Capital assets are taxed whenever they are sold at a profit. When you purchase goods or services with cryptocurrency, and the amount of crypto you spend has gained in value over what you paid for it, your spending incurs capital gains taxes.
Let’s say you bought $20 worth of Bitcoin and held it as it rose in value to $200. If you used the bitcoin to buy $200 worth of groceries, you’d owe capital gains taxes on the $180 in profit you’d realized—even though it seems as if you spent the Bitcoin, rather than sold it. For the IRS, it’s the same thing.
Therefore, when do you owe taxes on Cryptocurrency?
-If you mine cryptocurrency: Mining” crypto is when you use computers to solve complicated equations and record data on the blockchain. In exchange for this work, you may receive payment in new crypto tokens. You owe taxes on the entire value of cryptocurrency you’ve obtained by mining;
-if you receive cryptocurrency through a marketing promotion or an airdrop, it counts as taxable income;
-if someone pays you crypto for goods or services rendered, the entire payment counts as taxable income, just as if they paid you in cash (You customers may also owe income taxes if the crypto they are using to buy your services have increased in value);
-If you sell crypto for more than you paid for it, you owe tax on the gain;
-if you convert or exchange crypto—swapping bitcoin for ethereum, for example—you owe taxes on any gains you earn in the transaction. If you purchased $400 worth of bitcoin and used it to buy $1,000 worth of ethereum, you’d owe taxes on $600 in realized profit.
What if you have a loss? If you sell or spend your crypto at a loss, you don’t owe any taxes on the transaction and you could even use part of your Bitcoin losses to offset other investment gains.
How much do you owe in Taxes?
Just like for real estate properties, how much you owe in cryptocurrency taxes depends on your annual income and how long you’ve held your cryptocurrency.
-If you’ve owned your coins for less than one year before spending or selling them, any profits would be short-term capital gains, taxed at your normal income tax rate.
-If you’ve held your crypto for one year or more, any profit would be long-term capital gains, taxed at a lower rate, determined by your annual income.
Consulting a tax professional is absolutely crucial. There are a variety of deductions you can take on capital gains liabilities and there are a variety of tax credits and deductions that taxpayers can leverage to minimize the amount of income taxes actually due.
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