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The Ultimate Cryptocurrency Tax Guide

The IRS is putting cryptocurrency front and center this tax season. One of the first questions you’ll see on your tax return is, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” It’s important that you answer honestly. If you try to hide your cryptocurrency or provide inaccurate information, you could find yourself in hot water.

To help you better understand the potential tax implications of your crypto activities, we’ve put together this ultimate tax guide to ensure you stay compliant and out of trouble with the IRS.

Cryptocurrency & Taxes

In the United States, cryptocurrency is treated as property for tax purposes. Similar to stocks and bonds, you may incur capital gains and losses when you sell or trade your investments.

Purchasing cryptocurrency, however, doesn’t automatically mean that you’ll owe taxes. A taxable event must occur for there to be any tax burden. Per the IRS, the following activities constitute a taxable event:

  • Trading from a cryptocurrency to fiat currency, such as the U.S. dollar (USD)
  • Spending virtual currency on goods or services
  • Trading one cryptocurrency for another
  • Selling coins that were airdropped via a fork
  • Earning coins as income

If you purchase and hold your coins, however, you will not have to report or pay any taxes. Transferring cryptocurrency between wallets that you own is also a non-taxable event. 

How to Calculate Your Cryptocurrency Taxes

If you’re like most crypto investors, you probably bought, sold, or traded via an exchange, which means you’ll need to determine your capital gains and/or losses. To calculate the amount, use the following formula:

(Fair Market Value) – (Cost Basis) = Capital Gain

Fair market value (FMV) is the price the virtual currency would sell on the open market today. Cost basis is the amount you originally paid for the crypto. This not only includes the cost of the coin, but also any fees associated with the sale.

cryptocurrency capital gains
cryptocurrency capital loss

Determining the cost basis can get a bit more complicated, however, if you purchase coins over time at varying values. If you are trading or selling, you’ll need to identify which one is being used in the transaction. Many people use either the First-In-First-Out (FIFO) or the Last-In-First-Out (LIFO) method to determine the order in which they sell their currency. Either is fine, but you must remain consistent to ensure your calculations are correct.

Reporting Gains, Losses, and Income

Short-Term Gains

If you purchased your virtual currency and sell/trade it within less than a year, it’s considered a short-term gain and taxed as ordinary income. Depending on your tax bracket, that could be anywhere from 10 percent to 37 percent.

Long-Term Gains

Any cryptocurrency held for more than a year before being sold or traded is treated as a long-term capital gain. This is taxed at 0%, 15%, or 20%, depending on your income tax bracket.

Capital gains and losses are recorded on IRS Form 8949, Sales and Other Dispositions of Capital Assets. The totals from this form are then included on Form Schedule D, Capital Gains and Losses.

Ordinary Income

If you received virtual currency for services performed, the cryptocurrency is treated the same as other wages. You’ll be subject to income taxes, as well as self-employment taxes if you are a non-employee and received a 1099-NEC. Even if you don’t receive a form from the business that paid you, you will still be required to report the income and pay taxes. Any cryptocurrency you mine must also be included in your taxable income. Crypto income should be reported on Schedule 1, Additional Income and Adjustments to Income, or Schedule C, Profit or Loss From Business, if self-employed.

Cryptocurrency Tax Planning Tips

In 2019, the IRS sent letters to 10,000 taxpayers who owed back taxes because of cryptocurrency activities. They offered them the opportunity to file amended returns to avoid collection actions. It’s unlikely that the IRS will be so forgiving in the future, especially now that they have made it abundantly clear that they want to know about your crypto assets. To ensure you do not incur the wrath of the IRS, we suggest following these simple tax planning tips:

  • Keep Good Records – Use online software or a spreadsheet to track purchases, trades, and sales.
  • Pay Attention to Holding Periods – You can save yourself some tax money by waiting at least a year to sell or trade your coins.
  • Don’t Forget to Claim Losses – You can take up to $3,000 in cryptocurrency losses if you sold/traded for less than the original purchase price.
  • Keep Up With IRS Changes – Be sure to visit the IRS website to stay up-to-date on cryptocurrency tax-related news.
  • Work With a Tax Expert – If you’re new to the crypto world, consult with a tax expert to make sure you file all the necessary forms and your calculations are correct.

At Tax Defense Network, we offer affordable tax preparation packages and accounting services. To learn more about our cryptocurrency services, call 833-803-4222 and schedule a free consultation today!