How is crypto taxed? What is the crypto tax rate? What factors affect it? If you’ve got any questions on how your crypto transactions will be taxed, you’ve come to the right place.
As the IRS continues to write and revise cryptocurrency tax regulations, it’s becoming more important for crypto investors to understand just how and when their holdings are taxed.
In this article, we’ll cover the following:
- How is crypto taxed?
- What is the cryptocurrency tax rate?
- How is the crypto tax rate calculated?
- What crypto transactions are taxable?
- What are the tax implications of inheriting, gifting, or donating cryptocurrencies?
- What are other special considerations for cryptocurrency taxes?
- What are the IRS penalties for undeclared cryptocurrency?
How is crypto taxed?
In 2014, the IRS declared cryptocurrency is a digital asset rather than a fiat currency like USD. Since then, it’s been taxed the way other capital assets such as stocks, bonds, or property are taxed—on their capital gains.
Capital gains are taxed whenever you sell at a profit. When you buy products or services with cryptocurrency, and that cryptocurrency you spend has increased in value since you originally paid for it, you trigger capital gains taxes.
Like stocks, you only owe capital gains taxes on the realized profit you made at the time you sold or traded your cryptocurrency. If you incur a loss, you don’t owe any taxes on that transaction, although you must still report these crypto losses when filing your tax return.
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 ranged from 10-37% for short-term capital gains and 0-20% for long-term capital gains.
How is the crypto tax rate calculated?
Cryptocurrencies can be taxed as short-term capital gains or long-term capital gains.
If you sold or traded crypto in the United States, your capital gains tax rate is calculated using two factors:
- Your realized gains or losses
- Your holding period—how long you held the asset before selling or trading it
Your holding period begins the day after you either purchase crypto or make a crypto transaction and continues until the day you trade or sell the asset.
What are short-term capital gains?
If your cryptocurrency has a holding period of 365 days or less, it will be taxed as ordinary income and subject to short-term capital gains tax.
What are long-term capital gains?
If you hold a crypto asset for more than 366 days, it becomes subject to long-term capital gains tax rates. These rates vary between 0-20% based on your ordinary income tax rate.
What crypto transactions are taxable?
A taxable event is any event where you realize profits or losses. Anytime a taxable event affects your cryptocurrency investments, you’re obligated to report it on your taxes.
When it comes to crypto, these taxable events fall into two categories:
- Capital gains tax events
- Income tax events
It’s important to understand which events fall into their respective categories as they’re taxed differently.
What are crypto capital gains tax events?
The following activities are taxable as both short-term and long-term capital gains:
- Selling cryptocurrency for fiat currency such as the pound sterling, the euro, or the US dollar
- Using cryptocurrency to buy goods or services
- Swapping or trading one crypto asset for another
Selling cryptocurrency for fiat currency
For example, you buy 2 ether (ETH) for $500. You sell them for $1,000 three months later. You will report a short-term capital gain of $500 and be taxed on that amount.
If you buy 2 ETH for $1,000, then sell them for $700 a few months later, you’ll report and deduct a short-term capital loss of $300 and reduce your taxable income.
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 in a loss position to offset any capital gains.
Using cryptocurrency to buy goods or services
Let’s say you bought 5 bitcoin (BTC) for $150 each prior to 2014 and haven’t touched them since. To treat yourself, you used one BTC and bought a new Harley-Davidson for $56,000—the price of one bitcoin at the time of purchase.
With this transaction, you incurred a taxable event. As a result, you incur a long-term capital gain of $55,850—the difference between the value of the bitcoin when you bought it: $150, and the value of the bitcoin when you made the transaction: $56,000.
You need to report your transaction as a long-term capital gain on your taxes.
Swapping or trading one crypto asset for another
Swapping crypto assets are considered taxable events whether they’re traded directly peer-to-peer or on a cryptocurrency exchange.
Here’s an example: you bought 10 litecoin (LTC) for $500. After a few months, you traded all of your LTC for one ETH. When you made the trade, 10 LTC were worth $3,000.
In this transaction, you incurred a capital gain of $2,500—the difference between the value of the 10 LTC at the time of your purchase: $500, and the value of the LTC at the time they were traded: $3,000.
You’ll need to report $2,500 as a capital gain on your taxes.
It’s important to note, if you transfer an asset from one exchange or wallet to another, it isn’t a taxable event because it doesn’t trigger any capital gains or losses.
What are crypto income tax events?
The tax events the IRS has declared should be taxed as income include:
- Earning crypto interest from decentralized finance; often referred to as DeFi lending
- Receiving crypto via an airdrop
- Receiving crypto payment for carrying out a task; for example conducting bug bounties—scouring code for bugs in exchange for payment
- Earning crypto from staking and liquidity pools
- Earning crypto mining income from transaction fees and block rewards
What are the tax implications of donating, gifting, or inheriting cryptocurrency?
The IRS treats crypto donations the same 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 to it. The donor doesn’t owe any taxes on the price gain.
Crypto gifts below $15,000 aren’t 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’ll be subject to capital gains tax.
Inherited cryptocurrency assets are subject to the same estate regulations as other assets.
What are other special considerations for cryptocurrency taxes?
Crypto tax codes aren’t as simple as they seem. Due to price volatility, it can be difficult to determine the fair market value of the cryptocurrency during transactions. It’s also challenging to determine the right accounting approach to use when it comes to crypto taxation.
Crypto investors have used transaction strategies like Highest In, First Out (HIFO) and Last In, First Out (LIFO) to reduce the amount of income tax and capital gains tax they incur, however, the IRS has limited the situations these strategies can be used by crypto traders.
For now, the majority of traders use the First In, First Out (FIFO) strategy. If you have questions about the best tax-filing strategy for your crypto assets, consult our Crypto Tax Guide and a crypto tax professional.
What are the IRS penalties for undeclared cryptocurrency?
If you don’t report your cryptocurrency earnings, it could be deemed 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.
Even if you fail to report your crypto gains by mistake, you could receive a deficiency notice from the IRS and have the option to contest the notice or pay what you owe.
You could be 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 you deliberately underreported your earnings.
Taxbit is experienced in resolving cryptocurrency audits. For more information about how crypto taxes work, refer to our Crypto Tax Guide. Here are a few helpful articles:
- Start with Form 8949
- Take a look at other cryptocurrency tax forms
- Refer to the cryptocurrency glossary for unfamiliar terms
To continue learning about Cryptocurrency Tax Basics, see our additional articles in this series:
- Cryptocurrency Taxes
- Cryptocurrency Tax Forms
- Cryptocurrency Tax Reporting
- Taxes on Cryptocurrency Gains
- Cryptocurrency Tax Laws
- How to Report Cryptocurrency on Taxes
About Taxbit
Keeping up with all the paperwork and reporting regulations for digital asset transactions can be laborious and time-consuming. The more complex your crypto portfolio becomes, the more complicated your tax liabilities can get.
Taxbit helps track your crypto transactions and fills out your tax forms automatically.
We also recognize the need to support your DeFi activity, and each day we’re actively working on expanding DeFi support to popular blockchains.
The initial version of our DeFi support allows you to sync in any transfers, trades, and approvals you’ve made on a DeFi platform involving ERC-20 tokens on the Ethereum network, or BEP-20 tokens on the Binance Smart Chain network.
Ready to try out the updates for yourself? Create an account or login to start.
