Understanding the Cryptocurrency Tax Rate

What is the cryptocurrency tax rate? What factors affect the tax rate? How does it differ for mining vs. trading crypto? If you've got any questions on how cryptocurrency is taxed, you've come to the right place.

As the IRS continues to come down heavily on crypto tax compliance, it has become increasingly important to understand just how crypto is taxed.

In this post, we’ll cover what you need to know about crypto tax rates in 2021.

What is the cryptocurrency tax rate?

The cryptocurrency tax rate for federal taxes is the same as the capital gains tax rate. In 2021, it ranges from 10-37% for short-term capital gains and 0-20% for long-term capital gains. In the US, crypto-asset gains are calculated using two factors: your income, and how long you have held the cryptocurrency (holding period).

Your holding period begins the day after you purchase the crypto asset or make the cryptocurrency transaction and continues until the day that you trade/sell/send that capital asset. This is where short-term capital gains and long-term capital gains come in.

Short term capital gains and their tax rate: If your cryptocurrency coins have a holding period of 365 days or less, they will be taxed as ordinary income, and will be subject to short-term capital gains tax.

Here are the 2021 short term tax rates as released by the IRS earlier this tax year:

2021 short term capital gains tax rate

Long term capital gains and their tax rate: Coins with a holding period of more than 366 days are subject to long-term capital gains tax rates. These are tax liabilities between 0-20% and are based on what your ordinary income tax rate is.

2021 long term capital gains tax rate

Anytime a taxable event affects your cryptocurrency investments, you are obligated to report these on your taxes. What constitutes a taxable event? Any event in which you realize or trigger profits.

When it comes to crypto, these taxable events fall into two categories: capital gains tax events and income tax events. It’s important to understand what events fall into which category as they are taxed differently.

Capital gain tax events

Here are the short-term capital gain and long-term capital cryptocurrency gain tax events in which the cryptocurrency tax rates as of 2021 apply:

  1. Selling cryptocurrency for fiat currency (like the pound sterling, the euro, and the US dollar).

For example, you buy 2 ETH (Ethereum) for $1,000 and then sell them for $700 a few months later. The capital loss of $300 will get deducted and reduce your taxable income.

  1. Using cryptocurrency to buy goods/services.

For example, you bought 5 bitcoins in a bitcoin transaction for $150 each pre-2014. Now thanks to your newfound wealth, you use 1 bitcoin to buy a brand new Harley-Davidson for $56,000. At the time of buying the bike, 1 bitcoin is worth $56,000.

In this example, you incur a taxable event when you dispose of your bitcoin for the Harley-Davidson (i.e., you make a bitcoin transaction). As a result, you incur a capital gain of $55,850 ($56,000 – 150) and need to report it on your taxes.

  1. Swapping or trading one crypto asset for another.

This can be done either directly peer-to-peer or on an exchange.

Here is an example: you bought 10 Litecoin for $500. After a few months, you traded all of your Litecoin for 1 ETH (Ethereum). When you made the trade, 10 Litecoin were worth $3,000.

Here, you incurred a capital gain of $2,500 ($3,000 - $500) from trading your Litecoin for Ethereum and will thus need to report it on your taxes.

It’s important to note that if you were just transferring an asset from one exchange or wallet to another, that is not a taxable event as it does not trigger any capital gains or losses.

Income tax events

These include:

  • Earning crypto interest from decentralized finance (DeFi lending)
  • Receiving crypto via an airdrop
  • Receiving crypto payment for carrying out a task (this includes bug bounties)
  • Earning crypto from staking and liquidity pools
  • Earning crypto mining income from transaction fees and block rewards

Is cryptocurrency taxed like stocks?

The short answer is yes! The cryptocurrency tax rate is based on the IRS ruling (2014) that dictated all crypto should be treated like stocks or bonds (aka capital assets), rather than a fiat currency (like Euros or dollars).

You have to pay taxes whenever you sell your capital assets at a profit. So, when you buy products/services with digital currency transactions, and the amount of crypto you spend has increased in value over what you paid for it, you trigger capital gains taxes.

Just like stocks, you only owe capital taxes on crypto if you sell it or spend it and realize a profit. If you incur a loss, you don’t owe any taxes on that transaction, although you must still report these crypto losses when filing

For example, if you purchased $5,000 worth of Ethereum and sold it for $9,000, your taxable capital gain would be $4,000. However, if instead you sold it for $4,000, you wouldn’t owe anything in taxes since you incurred a loss ($1,000).

Capital losses on your cryptocurrency transactions can actually be beneficial for tax savings. By using a strategy called tax-loss harvesting, you can actually sell your cryptocurrency assets when in a loss position to offset any capital gains.

For more general information about how crypto taxes work, refer to our cryptocurrency tax guide. Here are a few helpful articles that we put together:

To continue learning about Cryptocurrency Tax Basics, see the additional articles in the series:

FAQs

Do I have to pay taxes if I am a Bitcoin miner?

Yes. Mining crypto is considered a taxable event in the US for tax returns.. The Fair Market Value at time of mining is considered income to the Bitcoin miner.

It should be noted that you can make business deductions for resources and equipment that you used to mine the Bitcoin.

The nature of these deductions will vary depending on whether you mined the Bitcoin for individual or personal gain.

For example, you can’t deduct anything if you mined the crypto for personal benefit. But you can take the deduction if you run a mining business.

What are the tax implications of inheriting, gifting, or donating cryptocurrencies?

As per the IRS rules, crypto donations are treated in the same way as cash donations – both are tax-deductible.

Based on the market price of the coin at the time, an appraiser will assign a fair market value for it. The donor doesn’t owe any taxes on the price gain.

Crypto gifts below $15,000 are not subject to gift taxes. If you receive a crypto gift and you decide to sell that gift, then your cost basis will be the same as that of the gift donor and you will be subject to capital gains tax.

Inherited cryptocurrency assets are subject to the same estate regulations as other assets as well.

What are some special considerations for cryptocurrency taxes?

Crypto investors should keep in mind that the taxation of crypto is not as simple as it may seem. Due to its price volatility, it is hard to determine the fair market value of the crypto on sale, purchase transactions, and overall cryptocurrency investment.

It’s also challenging to determine the right accounting approach to use when it comes to crypto taxation.

Strategies like Highest In, First Out (HIFO) and Last In, First Out (LIFO) can help reduce the amount of income tax and crypto gains tax.

However, the IRS has permitted very few situations of their use for crypto traders.

The majority of traders use the First In, First Out (FIFO) strategy as of now. It is also a good idea to consult a virtual currency advisor or crypto tax professional for the best tax advice.

What are the IRS penalties for undeclared Bitcoin?

Not reporting your Bitcoin earnings is deemed as Bitcoin tax evasion by the IRS. The department has taken several strict steps over the last few years to reduce any uncertainty about how crypto capital gains must be treated.

While in some cases it could be a simple mistake, the IRS probably won’t see it that way.

You will receive a deficiency notice from the IRS if you fail to pay your taxes. You’ll have the option to either contest this notice or pay what you owe.

Unfortunately, if you don’t pay your crypto taxes, you could get audited and may have to pay an understatement penalty of 20%.

This penalty could go up to 75% of the underpayment if the IRS finds that you deliberately underreported your earnings.

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