Trading crypto? Using it in transactions? Are you mining or staking? Your crypto is taxable
Do you own—or have you transacted in—crypto assets? Engaging in any cryptocurrency or digital asset transaction can trigger tax consequences—and nobody likes nasty surprises from the IRS. The type of transaction and whether you incur a gain or loss are two major factors that help determine your crypto tax bill.
Whether you’re an occasional crypto-dabbler, an active trader, miner, or anything in between, here’s what you need to know about cryptocurrency and taxes.
Key Points
- Different types of crypto transactions are taxed differently by the IRS.
- Buying and holding cryptocurrency is generally not taxable.
- Track your digital asset cost basis for tax purposes.
How cryptocurrency is classified for tax purposes
The Internal Revenue Service (IRS) classifies cryptocurrency as property, treating it like other investment assets such as real estate, stocks, and fine art. The core tenets of taxation that apply to property generally apply to digital assets, too.
Treating cryptocurrency as property may seem counterintuitive, given that it’s both virtual and used as a medium of exchange. But if you’re an investor or trader seeking exposure to digital assets, you need to understand the tax implications. Several transaction types can create capital gains or losses, all of which need to be reported at tax time.
Understanding crypto tax rules shouldn’t feel like deciphering ancient hieroglyphics. Let’s dig into what to expect for five common crypto transactions.
1. Buying cryptocurrency
Buying and holding cryptocurrency or another digital asset does not create a taxable event. Simply purchasing cryptocurrency is a lot like buying a piece of art and hanging it on your wall—at least for tax purposes.
But it’s important to keep track of your cost basis—what you paid for the tokens, including fees. You need to know the cost basis of all cryptocurrency purchases in your portfolio to accurately determine your tax bill.
If you buy and sell on a crypto exchange, the platform will often track your basis as a service to you as an account holder. But that’s only accurate for transactions within the platform. If you buy and sell on multiple exchanges, you’ll probably need to track your basis manually.
2. Selling cryptocurrency
Selling cryptocurrency triggers a taxable event. Your tax liability is determined by several factors:
- Profit. Your capital gain, or how much profit you earn from selling your cryptocurrency, plays a major role in determining the tax liability. Your profit from a crypto transaction is equal to the difference between the sale price and purchase price.
- Holding period. How long you hold cryptocurrency tokens impacts their tax treatment. If you sell cryptocurrency that you owned for more than a year, you’ll pay the long-term capital gains tax rate. If you sell crypto that you owned for less than a year, the proceeds will be taxed as ordinary income. If you prefer the capital gains tax rate, make sure to hold your crypto for more than a year.
- Tax bracket. Your tax bracket can also impact your crypto tax liability. Again, if you sell crypto that you owned for less than a year, any proceeds will be taxed at the same rate as income from other sources, such as your job. High-income earners who sell cryptocurrency frequently may face steep tax bills resulting from their crypto activity.
3. Trading digital assets
Another way to incur tax liability is by swapping out your digital assets. A crypto trade is divided into two parts—a sale and a purchase. If you sell Bitcoin to buy Ethereum, for example, then the IRS considers the two transactions separately.
Each transaction is treated like any other crypto sale or crypto purchase. Your profit from the sale generally determines your tax liability, and the purchase price sets the cost basis for the new tokens you acquire, in a manner similar to the buying and selling of property.
4. Spending cryptocurrency
Cryptocurrency holders can spend their tokens with merchants that choose to accept crypto. But the IRS views spending your crypto as selling it. That’s because the government deals in dollars and cents, so it considers your transaction as an exchange of your crypto for dollars—much like a foreign exchange transaction—followed by a transaction with the merchant at the dollar-equivalent value.
You’ll need to record the cost basis (purchase price) of the cryptocurrency at the time that you acquire it, and then note the value of your purchase when you spend it. The difference between the cost basis and value of the purchase is your capital loss or gain.
Whenever you buy something with cryptocurrency, it generally means you need to report the transaction at tax time. This reporting obligation can make cryptocurrency less useful for everyday purchases.
5. Earning crypto
You can be paid in cryptocurrency, whether it’s from cryptocurrency mining or staking, or via another profession. Any company can choose to pay their employees in cryptocurrency.
In each case, the cryptocurrency you receive is treated as ordinary income. The market price of the cryptocurrency on the day you receive it determines its value, your cost basis, and your income tax exposure.
What’s challenging about crypto taxes
In order to accurately report your cryptocurrency transactions at tax time, you’ll need to keep thorough records and precisely calculate your capital gains and losses. The sometimes decentralized nature of cryptocurrency transactions and the high volatility of cryptocurrency prices can make crypto taxes especially complicated.
Here are some of the primary challenges:
- Recordkeeping. Nobody likes tedious recordkeeping processes, which can arise with crypto taxes. Crypto owners need to use software or manually record the details of every transaction—its type, the cryptocurrency involved, the value in U.S. dollars at the transaction time, and the transaction date.
- Calculation. Conscientious recordkeeping helps, but calculating your capital gains can be complex and time-consuming. Many crypto investors and traders use software built into an exchange’s platform. That’s handy if you use one platform, but harder to track if you have more than one crypto account.
- Accuracy of crypto tax software. Software is available to support crypto holders’ recordkeeping and tax calculation needs, but it may not be fully comprehensive or accurate. It can be tough to verify if you are receiving complete and correct information.
- Tax law variations. The tax laws that govern cryptocurrency can vary across jurisdictions, creating more complexity for crypto holders. States and even municipalities can create their own rules for cryptocurrency, including its taxation. Crypto holders need to do their own research to ensure that they are complying with all applicable tax laws and regulations.
- Need for expert advice. The recordkeeping requirements and evolving nature of cryptocurrency tax rules can create a need for expert advice. Not every crypto investor wants to pay for the services of a crypto tax professional, although they can provide customized guidance and help with tax compliance.
The bottom line
Understanding crypto taxes is crucial for crypto investors—but that doesn’t mean you need to become an amateur accountant simply to add crypto to your portfolio. Understanding the fundamental principles of cryptocurrency taxation is a major leap in the right direction. Just remember to keep complete and accurate records, or get reliable help with your recordkeeping.
This article is intended for educational purposes only. Encyclopædia Britannica, Inc., does not provide legal, tax, or investment advice.