Every crypto-to-crypto transaction, regardless if it generates a capital gain or loss, must be reported on your tax return.
Public companies and private investors alike are increasingly interested in cryptocurrency investments.
In early 2021, Tesla joined the likes of MicroStrategy and Square by purchasing $1.5 billion of bitcoin (BTC). Today, 14% of American adults are now crypto investors, and a further 63% report interest in joining their ranks according to a 2021 report from Gemini.
Whether you’re actively investing in crypto, or just thinking about it, it’s important to stay aware of changing regulations and related tax implications around crypto reporting.
Here’s what you should understand about exchanging crypto assets and the related cryptocurrency tax laws.
Is exchanging one crypto for another a taxable event?
Every crypto-to-crypto transaction, regardless if it generates a capital gain or loss, must be reported on your tax return.
The IRS treats cryptocurrency and other digital assets as property, so if a cryptocurrency investor exchanges one crypto asset for another, it triggers a taxable event, it’s required to be reported to the IRS.
The crypto-to-crypto trade will likely result in a capital gain or loss. That capital gain or loss is equal to the difference between your cost basis—or original purchase price—in the original asset and the fair market value of the asset being acquired.
What’s an example of capital gain on a crypto-to-crypto transaction?
Consider the following example. You acquired 0.5 BTC when it was worth $15,000. After holding it for six months, its value rose to $25,000.
You decide to exchange your 0.5 bitcoin for two ether (ETH) worth $25,000.
Because ETH is worth more than the purchase price, or cost basis, of your original BTC transaction, you trigger a taxable capital gain equal to the difference—in this case, $10,000.
What’s an example of capital loss on a crypto-to-crypto transaction?
If you trade your crypto for another digital currency worth less than your cost basis, you’d have a capital loss. Crypto losses can actually help you reduce your tax liability for the year.
For example, let’s say you purchase 0.5 BTC for $10,000. The value drops to $6,000, and you trade it for 0.25 ETH worth $6,000, resulting in a capital loss of $4,000.
The transaction is still considered taxable and must ultimately be reported on your income tax returns. Even though you didn’t have a capital gain, you must still report that taxable event.
However, with capital losses, you could use tax-loss harvesting to offset other capital gains you generate during the year.
What crypto transactions often result in taxable events?
In general, your crypto activities will constitute a taxable event if you dispose of your crypto.
Some of the most common taxable dispositions are:
- Selling crypto for fiat currency
- Spending crypto on goods or services
- Earning crypto income
- Trading one crypto for another form of crypto
Selling crypto for fiat currency
Selling your virtual currency for fiat currency is a traditional way to dispose of digital assets.
Sales are often initiated through cryptocurrency exchanges. You receive the fair market value of the digital asset in your selected fiat currency.
If you receive a higher price for the sale of the asset than its cost basis, the transaction is a taxable event, and you owe capital gains tax on the difference.
Spending crypto for goods or services
It’s become much more feasible to pay for goods and services using digital assets, but spending crypto counts as a disposal. If the value of your crypto has gone up since you purchased it, spending it on any goods or services will trigger a taxable event.
Earning crypto income
Disposing of crypto isn’t the only way to generate a taxable transaction. In addition to capital gains or losses, your cryptocurrency investments and activities can generate ordinary income.
These activities traditionally include:
- Crypto mining income
- Staking income
- DeFi income
- Airdrops and hard forks
- Payment for services in crypto
These are all taxable, and you’ll generally have to include any assets received as income at their fair market value on the date you received them.
If any of these activities constitute a business, you could net them against the ordinary and necessary expenses incurred while performing them. For example, if you mined cryptocurrency during the tax year, you potentially could deduct the cost of equipment and energy. Note that most people’s mining activities are a hobby and not a business.
To learn more about the IRS guidance on crypto mining, please read our article.
What crypto transactions aren’t taxable events?
In general, there are certain activities that aren’t considered dispositions of crypto, and don’t have taxable outcomes.
Common activities that don’t result in a taxable event are:
- Buying crypto with fiat currency
- Transferring crypto between wallets or exchanges
- Giving crypto as a gift
- Donating crypto to a qualifying organization
Buying crypto with fiat currency
Buying crypto with fiat currency is similar to investing cash in another capital asset like a stock or bond. This is simply a purchase of that asset. It establishes your cost basis for tax purposes, but won’t trigger a taxable event.
Transferring crypto between wallets or exchanges
Transferring your digital assets between wallets or across exchanges isn’t considered a taxable event under the current tax law since it’s not changing ownership and doesn’t produce any gains or income.
The IRS confirmed this in Question 38 of their resource, Frequently Asked Questions on Virtual Currency Transactions.
Giving crypto as a gift
Giving your crypto away as a gift is one of the few ways it can be disposed of after without having to recognize capital gains after it’s increased in value.
Currently, there are two tax exclusions for gifts:
- Annual gift tax exclusion—$15,000 per person for the 2021 tax year
- Lifetime gift tax exemption—$11.7 million for the 2021 tax year or $23.4 million if filing jointly
You can give up to $15,000 worth of crypto per person in a year without triggering the annual gift tax as of the 2021 tax year. Also, this doesn’t count against the amount of lifetime gift tax exemption. For example, you could give 1 ETH worth $10,000 each to your five nieces and nephews without triggering the gift tax.
However, if you gave all 5 ETH worth $50,000 to one niece, you’d exceed the annual exclusion by $35,000, and reduce your lifetime exclusion by the same amount.
Whether you’d benefit more from giving your cryptocurrency to the recipient directly, or selling it and passing on the proceeds, depends on whether the value has increased or decreased since your purchase.
Donating crypto to a qualifying organization
Donating your crypto isn’t a taxable transaction. However, while you can gift your crypto to anyone, you’ll have to make sure the donation recipient is a qualifying organization.
Donating your crypto to a qualifying organization has more tax implications than simply giving it away to an individual. Most notably, you can take a deduction for a donation, but not a gift.
The available deduction depends on your holding period. If you hold the asset for longer than a year before donating, you can use the fair market value on the date of donation. If you dispose of it within a year, you can only deduct up to the cost basis.
For example, imagine you bought 1 ETH for $4,000. Six months later, it’s worth $5,000. At that point, you could donate it to a qualified organization, but only take a $4,000 deduction.
You could try to wait another six months to receive a deduction at fair market value, but there’s no guarantee the price of ETH will hold.
How is crypto taxed?
There are two types of cryptocurrency taxes, each of which has its own tax rate:
- Long-term capital gain tax
- Short-term capital gain tax
Here’s how they work and how to sort any taxable income into each group.
What is long-term capital gain tax?
If you hold your crypto asset for more than a year before exchanging it for another, selling it for fiat currency, or using it to buy something, the transaction will be subject to long-term capital gain tax rates.
Long-term capital gains tax rates are significantly lower than ordinary income rates and can be 0%, 15%, or 20%, depending on the taxpayer’s income for the year.
For example, if you were to buy .5 BTC for $20,000 and hold onto it for two years, then exchange it for four ETH worth $35,000, you’d have a long-term capital gain of $15,000.
If your only other income in the year that you make the exchange is a salary of $100,000, you’d fall into the 15% capital gain tax bracket and have a $2,250 cryptocurrency tax liability.
What is short-term capital gain income tax?
If you dispose of your crypto asset within 12 months of acquiring it, unless you give it away or donate it, you’ll owe short-term capital gains tax on any profits you’ve generated.
Short-term capital gains are subject to your ordinary income tax rate, just like any earnings from activities like mining, staking, or airdrops.
Your tax rate on the income will be somewhere between 10% and 37% depending on your adjusted gross income for the year.
For example, imagine you successfully mined 1 BTC when it was worth $10,000. Six months later, you sell it for $15,000 of fiat currency. Your only other income for the year is a $100,000 salary.
Your marginal income tax rate as a single filer would be 24%.
Assuming the mining activities were a hobby, you’d report $10,000 of mining income and $5,000 in short-term capital gains on your IRS tax forms. Your total cryptocurrency tax liability would be $3,600 for the tax year.
Check out our article on the cryptocurrency tax rate to learn more.
How Taxbit can help
As you can tell, navigating crypto reporting requirements is complicated.
Taxbit can help you optimize your trading and organize all the necessary records at the end of the tax year.
The Taxbit Network now provides users the ability to:
- Easily integrate their cryptocurrency exchange, DeFi, and NFT data from over 500+ sources
- See their tax calculations line-by-line and aggregate tax positions
- Download completed IRS Forms 8949 and income reports ready to upload to popular tax filing software or hand over to an accountant
All these services are FREE for users of supported Taxbit Network companies.
Want to learn more about reporting your cryptocurrency activities to the IRS? Take a look at our resources:
