Cryptocurrency Tax Laws: What U.S. Taxpayers Should Know as Tax Day Approaches

By Seth Wilks, Director of Government Relations

Did you trade or sell Bitcoin, Ether, or other digital currencies in 2020? If so, you’ll have information you need to report on your tax return. With the tax deadline rapidly approaching, TaxBit’s CPAs and tax attorneys are breaking down the cryptocurrency tax laws to make this process as simple as possible.  Contrary to popular belief, taxes on crypto doesn’t always equate to bad news. If you sold crypto at a loss or donated or gifted crypto in 2020, you may actually be able to reduce your tax liability. 

Let’s start with the basics.

Do you pay taxes on cryptocurrency?

Yes, you pay taxes on cryptocurrency gains when you dispose of an asset, much like stocks.  This could include: selling your crypto for cash, trading one cryptocurrency for another, or using crypto as payment.  You could also pay taxes on cryptocurrency earned as income through mining, staking, or getting paid in crypto.  

And the IRS is serious about enforcing this.  This year, for the first time, the IRS added a new question to Form 1040 that asks taxpayers, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
If you don’t report your crypto taxes, the IRS can prove intentional disregard for knowingly failing to report this. 

However, not every crypto activity receives the same tax treatment—and this is where things can get confusing for crypto investors.  To clarify, let’s dive into how cryptocurrency is taxed, and how these tax laws apply to some of the most common crypto activities.

What are the cryptocurrency tax rates?

If you received cryptocurrency as income, it will be taxed at your ordinary income rate.  If you dispose of cryptocurrency, however, any profits will be taxed at the capital gains tax rate, which varies based on how long you held the asset and your income.  

If you held crypto for over a year before selling, your capital gains will be taxed at the long-term capital gains rates in the table below. 

Alternatively, if you sold crypto after holding for less than one year, these gains will be taxed at the short-term capital gains rates, which is the equivalent of your ordinary income rate in the below table.

Common crypto activities and how they’re taxed

Buying Crypto 

Good news for all you crypto hodlers! Buying Bitcoin or other cryptocurrencies is itself not a taxable event.  You only pay taxes on this crypto when you dispose of it (trading, selling, or using as means to purchase).  However, it’s still important to keep track of this activity as it does set your cost-basis when you do dispose of your crypto.

Selling crypto for fiat

Selling crypto for fiat currency is taxable as property, meaning any gains will incur a capital gains tax.  You will need to report your capital gains and losses on IRS 8949.  For example, if you buy $2000 of ETH (this is your cost-basis) and later sell it for $2500, you would incur a capital gain of $500.

Trading crypto for crypto

Trading one coin for another is again taxable as property and will need to be reported on your IRS 8949 form. For this example, let’s say you bought 2 Litecoin for $500 (this is your cost-basis).  Later in the year, you traded all of this Litecoin for ETH.  When you made this trade, Litecoin had gone up in value and the new value of 2 LItecoin was $750. You would have incurred a capital gain of $250.

It’s important to note that if you were just transferring coins from one exchange or wallet to another, this is not a disposition and is therefore not taxable.  

Using crypto to purchase goods or services

Using crypto as payment for goods and services constitutes a disposal and any gains or losses will need to be reported on Form 8949.  Note that this includes any purchases made on cryptocurrency debit cards!

Mining or staking cryptocurrency

Any crypto earned through mining or staking crypto is taxable as income.  Unlike the above examples, any profits here will be subject to ordinary income tax rates, not the capital gains tax rate. The amount taxed will equal the asset’s fair market value at the time the coin is mined, not sold.  

Note that if you then sold this crypto, it would trigger a second taxable event and you would be required to report this capital gain or loss on Form 8949.

Airdrops and hard forks

Any crypto received from an airdrop, resulting from a hard fork or other reason, is taxed at the ordinary income rate. The amount taxed is the fair market value of the crypto at the time it was received. 

Getting paid in crypto

Like mining or staking cryptocurrency, any money earned from getting paid in crypto is taxable as income and must be reported on Form 1040.  

What about crypto losses?

Cryptocurrency losses must be reported on your IRS 8949 just like cryptocurrency gains.  There is a silver lining here, though.  If you disposed of your crypto at a capital loss, you can use this loss to offset your capital gains or claim the capital loss deduction.  

With the capital loss deduction, you can deduct up to $3,000 in capital losses a year.  And, if you had more than $3,000 in net capital losses, then you can carry forward this amount into future years to offset capital gains or claim the capital loss deduction again.  

Cryptocurrency gifts and donations

More good news! Donating or gifting cryptocurrency are not taxable events, so you will not recognize any gains or losses when gifting or donating.  

Additionally, if you held the cryptocurrency for more than one year before donating, then you will be eligible for the itemized charitable deduction for the fair market value of the cryptocurrency at the time of contribution.  

If you donate after holding the cryptocurrency for less than one year, you are still eligible for the itemized charitable deduction, but your deduction will be limited to the amount you obtained the crypto at (your cost-basis).  

It’s important to note that the deduction is only applied to donations to a qualified charitable organization. Other gifts, such as a graduation present or crypto crowd-funding, are not eligible for the deduction.  

NFTs

In most cases, NFTs (non-fungible tokens) are subject to the same tax laws as fungible cryptocurrencies. If you’re an artist who earned money from selling an NFT, this amount would need to be reported as income on your tax return.  And if you invest in NFTs, any profits earned through sales or trades will be taxed as property and subject to the capital gains tax.  

Keep these most common activities in mind when filing your taxes:

• If you purchased an NFT using a fungible crypto token like Bitcoin or Ether, you will have to report your capital gains (or losses) that resulted from the crypto sale
• If you sold one NFT for another NFT, you must report the capital gains or losses
• If you sold one NFT for a fungible crypto asset, you must report capital gains or losses

Quick crypto tax savings tips:

As you probably picked up from the above, cryptocurrency taxes can be convoluted, particularly for those making numerous trades. However, when you understand the crypto tax laws, you can identify ways the laws allow for tax savings.  Here’s a few tips you can apply now—and throughout the year—to save money on your crypto taxes:

• Donate and gift appreciated crypto assets to avoid the capital gains tax (and for donations, claim the charitable tax deduction!)
• Claim the crypto capital loss deduction for up to $3,000 per year (and carry over any losses over $3,000 to future years)
• Wash sale rules don’t apply to crypto, so sell your crypto assets in loss positions and buy back to offset any capital gains.

Get the Cryptocurrency Trading Tax-Loss Harvesting Guide to learn more about making smarts to minimize your taxes. 

If you’re delaying your crypto taxes out of fear or uncertainty, TaxBit is here to help.  Founded by CPAs and tax attorneys, TaxBit automates all aspects of crypto tax reporting from start to finish.  Get started now with 10% off.