Overview: The staying power of cryptocurrency is still a matter of some debate, but the reality is that many people have made significant profits from investing in it. But are those profits taxable? If you own cryptocurrency, you need to know! Read on for some info on how the IRS taxes these investments and what constitutes a taxable event.
With the staggering rise in the cryptocurrency and digital token such as Ethereum and Bitcoin, investors may have serious questions about how tax laws apply to this relatively new world. The Internal Revenue Service (IRS) is gradually stepping up enforcement efforts, and anyone who buys or sells cryptocurrency needs to ensure that they don’t run afoul of the law. Fortunately, it might be easier than you think!
>> Related Reading: What Is Cryptocurrency?
“It’s a really big enforcement area for the IRS right now,” says Brian R. Harris, tax attorney at Fogarty Mueller Harris, PLLC in Tampa. “They’re generating a lot of publicity in going after people who hold, trade or use cryptocurrency. Those people can be a target for audit or compliance verification.” (Source: HR Biz)
“The IRS and FBI are getting better at tracking and tracing Bitcoin as part of criminal investigations,” says Harris. And they can freeze assets if needed, he adds.
Although cryptocurrency operates outside traditional financial systems, it’s still subject to taxation in most countries. Understanding the tax implications of cryptocurrency can be complex, as it involves navigating an intricate mapping and rapidly changing landscape of regulations and rules.
This guide will provide an overview of the tax considerations for cryptocurrency, including the types of taxes that may apply, how to calculate your tax liability, and how to stay compliant with tax laws while investing in cryptocurrency.
What is Cryptocurrency?
Cryptocurrency is a type of digital currency that uses encryption techniques to regulate the generation of units of currency, and to verify the transfer of funds. Unlike traditional fiat currency, which is issued and controlled by a central authority, crypto-currencies are decentralized and operate on a peer-to-peer network.
Bitcoin was the first cryptocurrency, introduced in 2009, and has since been joined by a host of other digital currencies, including Ethereum, Litecoin, and Ripple.
>> Related Reading: The basics about cryptocurrency
How Is Cryptocurrency Taxed?
The taxation of cryptocurrency can be a complex and confusing topic, and the laws vary by country. However, in general, cryptocurrency is treated as property for tax purposes. This means that any gains or losses from the sale or exchange of cryptocurrency are subject to capital gains tax.
In the United States, the Internal Revenue Service (IRS) has provided guidance on how to report cryptocurrency transactions on tax returns. According to the IRS, any time you sell or exchange cryptocurrency, you must report the transaction on your tax return and pay capital gains tax on any profits.
The amount of tax you owe on your cryptocurrency gains will depend on how long you held the cryptocurrency. If you held the cryptocurrency for less than a year, you’ll pay short-term capital gains tax, which is the same as your ordinary income tax rate. If you held the cryptocurrency for more than a year, you’ll pay long-term capital gains tax, which is usually lower than the short-term rate.
It’s worth noting that the IRS has also stated that receiving cryptocurrency as payment for goods or services is treated as ordinary income, and must be reported on your tax return. If you’re paid in cryptocurrency, you’ll need to report the value of the cryptocurrency at the time of receipt as income on your tax return.
You might be interested in reading this guide provided by the IRS itself: Frequently Asked Questions on Virtual Currencies Transactions
6 Important Things to Know About Crypto Taxes :
Here are 6 important things you should know about cryptocurrency taxes.
Cryptocurrency is considered property for tax purposes: The IRS considers cryptocurrency to be property, not currency, for tax purposes. This means that every time you sell, trade, or exchange cryptocurrency, it is a taxable event. Just like with any other property, you must report any gains or losses on your tax return.
Crypto-to-crypto trades are taxable: If you trade one cryptocurrency for another, it is considered a taxable event. This means that you must report any gains or losses on your tax return, even if you didn’t convert the cryptocurrency back to fiat currency.
Crypto mining is taxable: Mining cryptocurrency involves using computer processing power to solve complex mathematical equations and validate transactions on the blockchain. Any cryptocurrency you receive from mining is considered taxable income, and you must report it on your tax return.
Cryptocurrency forks and airdrops are taxable: Cryptocurrency forks occur when a blockchain splits into two, creating a new cryptocurrency. Airdrops, on the other hand, occur when a cryptocurrency company distributes new tokens to existing holders for free. Both of these events are considered taxable income, and you must report them on your tax return.
Tax laws are constantly evolving: The tax laws surrounding cryptocurrency are still evolving, and it’s important to stay up to date on any changes that may impact your tax liability. Make sure any advice you receive is applicable to current cryptocurrency tax laws!
Failure to report cryptocurrency can result in penalties: If you fail to report your cryptocurrency transactions on your tax return, you may be subject to penalties and fines. The IRS has taken a more aggressive stance on cryptocurrency tax enforcement in recent years, and they are actively pursuing cases of non-compliance.
Simply put, owning, trading, and investing in the cryptocurrency has significant tax implications, and it’s important to understand the rules and regulations surrounding these digital assets. By staying informed and working with a knowledgeable tax professional, you can ensure that you stay compliant and minimize your tax liability.
How to Keep Track of Cryptocurrency Transactions
Keeping accurate records of your cryptocurrency transactions is crucial for accurately reporting your taxes. The IRS has stated that taxpayers must maintain records of their cryptocurrency transactions, including the date, value, and purpose of each transaction.
To keep track of your cryptocurrency transactions, you can use a cryptocurrency exchange, which will provide you with a record of your trades. You can also use a cryptocurrency tracking app, such as CoinTracker or CoinLedger, which can help you track your transactions and calculate your tax liability.
It’s important to note that many cryptocurrency exchanges do not provide users with a complete record of their transactions, so it’s up to you to keep track of your transactions and maintain accurate records.
Tax Tips for Cryptocurrency Investors :
Here are some tips to help cryptocurrency investors navigate the tax landscape:
Keep accurate records: As mentioned, it’s crucial to keep accurate records of your cryptocurrency transactions to ensure that you report your taxes correctly. Make sure to keep track of the date, value, and purpose of each transaction.
Be aware of the tax implications of mining cryptocurrency: If you mine cryptocurrency, the IRS considers it as income, and you’ll need to pay income tax on the value of the cryptocurrency.
Don’t forget about the Foreign Account Tax Compliance Act (FATCA): If you have cryptocurrency stored on an overseas exchange, you may need to comply with FATCA, which requires foreign financial institutions to report on the financial accounts of US taxpayers.
Consider using a tax professional: If you’re unsure about how to report your cryptocurrency transactions on your tax return, consider working with a tax professional who is familiar with the taxation of cryptocurrency.
Consider tax-loss harvesting: If you’ve experienced losses in your cryptocurrency investments, you may be able to consider tax-loss harvesting: If you’ve experienced losses in your cryptocurrency investments, you may be able to offset some of your gains by selling the losing investments before the end of the tax year. This strategy is known as tax-loss harvesting and can help reduce your overall tax liability.
Understand the implications of hard forks and airdrops: Hard forks and airdrops can result in the creation of new cryptocurrency tokens, which can have tax implications. If you receive new cryptocurrency tokens through a hard fork or airdrop, you may need to pay income tax on the value of the new tokens.
In Summary:
Cryptocurrency taxation can be a complex and confusing topic, but it’s important to understand the tax implications of your investments to ensure that you stay compliant with the law when dealing in Bitcoin, Ethereum, Litecoin, or any other cryptocurrency. Keeping accurate records, understanding the tax implications of mining, considering tax-loss harvesting, and being aware of the implications of hard forks and airdrops are all important factors to keep in mind.
While the tax landscape for cryptocurrency is still evolving, it’s important to stay informed and work with a tax professional if you’re unsure about anything related to your tax returns. At Prospect Financial Solutions, we’re Southern California’s premier tax & accounting firm, and we’d love to work with you on your finances. Contact us today!
