One of the least talked about subjects discussed throughout the rapid growing crypto market is taxes.
Here's the issue, in the U.S., cryptocurrencies like bitcoin are treated as property for tax purposes. This must be understood by everyone: The purchase of digital assets, of any kind is a "taxable event". What is a taxable event? A taxable event simply refers to a scenario in which you trigger or realize income. As seen in the IRS virtual currency guidance, the following are all considered taxable events for cryptocurrency:
If you sell at a profit, you may owe taxes. If you sell at a loss, you may not owe taxes. Your still required by law to record such transactions. Unfortunately every single one of them.
Please understand, cryptocurrency taxes can become a very messy business. Its important to stay on top of them.
Just like other forms of property like stocks, bonds, and real-estate, you incur capital gains and capital losses on your cryptocurrency investments when you sell, trade, or otherwise dispose of your crypto.
For example, if you bought $10,000 worth of bitcoin in October and sold it two months later for $12,000, you would incur a $2,000 capital gain from the sale of your bitcoin (12,000 - 10,000).
Depending on what tax bracket you fall under, you will pay a certain percentage of tax on this capital gain. Tax rates fluctuate based on your personal tax bracket and whether the gain was short term or long term (more on this later).
Outside of buying, selling, and trading, if you earn cryptocurrencies—whether through a job, mining, staking, airdrop, or interest from lending activities—you are liable for income taxes on the US Dollar value of your crypto earnings.
We will walk through examples for all of these scenarios further below.
Whenever you incur a taxable event from your crypto investing activity, you also incur a tax reporting requirement. Please remember this.
Below, we run through practical examples to illustrate each of these taxable events.
Alika buys 2 ETH from Gemini for $1,200 each. A few months later, Alika sells his 2 ETH for $1,000.
Selling crypto for fiat currency is a taxable event. In this example, Alika incurs a $400 capital loss, $1400-$1000. This loss gets deducted and actually reduces Alikas taxable income.
Sean purchases 5 Litecoin for $200 each. After holding onto his Litecoin for a couple of months, Sean trades all 5 Litecoin for 1 ETH. At the time, 1 ETH is $1500.
In this scenario, Sean incurs a taxable event by trading his Litecoin for Ethereum. Trading one crypto for another is treated as a disposal, and here Sean incurs a $500 capital gain from the trade which he would need to report on his taxes.
Taylor owns 5 bitcoin, each of which she bought for $100 pre-2014. Taking advantage of her new found wealth, Taylor uses 3 bitcoin to purchase a new Tesla for $51,000. At the time of buying the car, 1 bitcoin is worth $17,000.
In this example, Taylor incurs a taxable event when she disposes of her bitcoin for the new Tesla. She incurs a $50,700 capital gain in doing so (51,000 - 300) and needs to report this capital gain on her taxes.
Jake runs a cryptocurrency mining operation. Every day, Jake mines 0.5 bitcoin through his crypto mining rigs.
In this example, Jake would recognize income for the USD value of 0.5 bitcoin each day. If Jake mined 0.5 bitcoin today on April 20th, 2020, he would recognize $9,750 of income (as bitcoin is currently trading at $19,500 per coin).
In certain circumstances, you will not trigger any taxable events when transacting with crypto, and you will not have to pay or report any cryptocurrency taxes.
You do not trigger a taxable event when you:
If you simply buy bitcoin or another cryptocurrency and hold it in a wallet, you do not have any sort of tax reporting requirement as you haven’t realized a gain or loss on your investment yet.
Once you sell, trade, or trigger a taxable event by disposing of the coin, this is when you realize a capital gain or loss.
Sending one cryptocurrency from one wallet you own to another wallet you own is not a disposal of your crypto. You still own the crypto, and thus you do not trigger a taxable event.
To calculate your capital gains and losses from each of your crypto sells, trades, or disposals, you simply apply the formula:
Fair Market Value - Cost Basis = Capital Gain/Loss
Fair Market Value is simply the price an asset would sell for on the open market. In the case of cryptocurrency, this is typically the sale price in USD terms.
Cost Basis represents how much money you put into purchasing your property (i.e. how much it cost you). Cost basis includes purchase price plus all other costs associated with purchasing your cryptocurrency (fees, etc).
From our examples above, it’s easy to see this formula in action. If you buy 1 Litecoin for $250, your cost basis is $250 per Litecoin. If you sell or trade it when it’s worth $400, that $400 is the fair market value. Applying the formula:
$400 (Fair Market Value) - $250 (Cost Basis) = $150 Gain
Now, let’s dive into a more complex example to see how you would calculate your gains and losses using this same formula when you have a number of transactions instead of just one or two.
Say you have the following transaction history on Coinbase:
With this transaction history, you first trigger a taxable event (and thus a capital gain/loss) when you trade 0.5 BTC for 8 ETH. To calculate the gain/loss, you need to subtract your cost basis of 0.5 BTC from the fair market value at the time of the trade.
The question here is, what is your cost basis in the 0.5 BTC that you traded for 8 ETH? After all, you have purchased 3 different bitcoins all at different prices prior to this trade.
To answer this, you have to determine which bitcoin you are disposing of in this scenario.
To determine the order in which you sell various cryptocurrencies, accountants use specific costing methods like First-In First-Out (FIFO) or Last-In First-Out (LIFO). The standard method is First-in First-out.
These costing methods work exactly how they sound. For First-In First-Out, the asset (or cryptocurrency) that you purchased first is the one that gets sold off first. So you are essentially disposing of your crypto in the same order that you first acquired them.
If we use First-In First Out for our example above, we “sell off” that first bitcoin which was acquired at $12,000 on 1/1/20. The cost basis in this first bitcoin is $12,000, making the cost basis for 0.5 of this BTC $6,000 (0.5 * $12,000).
As denoted in the example, the fair market value at the time of 0.5 BTC at the time of trading was $4,000.
So by applying the formula, we can see that this transaction history triggers a $2,000 capital loss (4,000 - 6,000). This loss gets reported on your taxes and reduces your taxable income.
You can learn more about how various costing methods work to calculate your gains and loss for your crypto trades in this blog post: FIFO, LIFO, and HIFO for crypto trading.
As you can see throughout the examples above, to calculate your capital gains and losses from your crypto trading activity, you need to have records that keep track of your cost basis, fair market value, and USD gain or loss every time you dispose of a crypto (trade, sell, spend etc).
Without this information, you aren’t able to calculate your realized income from your trading activity, and you aren’t able to report it on your taxes.
This is extremely challenging for many cryptocurrency investors as most haven’t been keeping detailed records of their investing activity. Trying to track the cost basis and USD prices for all of their cryptos across all of their exchanges, wallets, and protocols at any given time quickly turns into a difficult, if not impossible, spreadsheet exercise.
This is the reason why hundreds of thousands of crypto traders are turning to crypto tax software like CryptoTrader.Tax to automate all of their crypto tax reporting. You can sign up for a free account here.
If you’re like 90% of other cryptocurrency investors, you likely have only bought, sold, and traded crypto (i.e. capital gains investing activity) via a cryptocurrency exchange. This crypto income is considered capital gains income and is reported as such.
On the other hand, if you earned cryptocurrency—whether that's from a job, mining, staking or earning interest rewards—that earned income is generally treated as ordinary income and is reported as such.
We dive into the reporting for each of these income types below.
Your capital gains and losses from your crypto trades get reported on IRS Form 8949.
Form 8949 is the tax form that is used to report the sales and disposals of capital assets, including cryptocurrency. Other capital assets include things like stocks and bonds.
To fill out Form 8949, list all of your cryptocurrency trades, sells, and disposals onto Form 8949 (pictured below) along with the date you acquired the crypto, the date sold or traded, your proceeds (Fair Market Value), your cost basis, and your gain or loss for the trade.
Please check out CryptoTrader.Tax — The #1 Crypto Tax Software
Note: "The 1099-K is mandatory for a customer who in one calendar year does at least 200 transactions with proceeds totaling at least $20,000." Source: Forbes