Cryptocurrency is a hot topic across financial resources and social media alike. With recent huge price surges, it is easy to see why it is on many investors’ minds. Bitcoin (BTC) passed a value of $60,000 earlier this year, and Ethereum (ETH) quadrupled since the beginning of 2021. Even those who have never traded before are excited to get on the cryptocurrency bandwagon.
Many people forget (or may not realize at all) that investing in cryptocurrency is just like making money off of other types of investments—namely, you have to pay taxes on your earnings. Because cryptocurrencies are so new and somewhat amorphous, the tax structure that applies to them is somewhat in question. However, because the IRS is certainly not going to let a potential tax opportunity get away, they have created a means to tax income based on cryptocurrencies.
How is Cryptocurrency Taxed?
Cryptocurrency is treated like other types of investment property (such as stocks and bonds). As a rule, then, you will be taxed if you sell cryptocurrency and make any profit from that sale.
The tax is based on the difference between the value of the crypto when you bought and the value when you sold it. The value at which you purchased the asset is called the “basis.” If the proceeds exceed your basis (if you sold it for a gain), then you have a capital gain. If you sold it at a value less than your basis, then you have a capital loss.
Short-Term and Long-Term Capital Gains
There is also a distinction in how much the tax will be based on how long you have owned the crypto—just like stocks and bonds. If you hold the currency for less than one year, then it will be taxed as a short-term gain. That tax rate is the same as your traditional income tax rate. Those rates range from 0% to 37% as of 2021, and they vary based on the amount of other income you have.
If you hold the cryptocurrency for more than 365 days, then it is taxed as a long-term capital gain. That rate also depends on your income, but it is often less than the short-term tax rate. It will be either 0%, 15%, or 20%.
You can also use losses from cryptocurrency to offset income tax by up to $3,000 as well.
Wash Sales: Offsetting Losses
Just like other stocks and bonds, if you experience any losses throughout the year, those will offset your capital gains. However, if you sell a losing stock too fast, then you cannot use those losses to offset the gains. This is called a wash sale. It generally involves the following process:
- Selling the cryptocurrency at a loss and then
- Buying more of the same crypto within 30 days (either through a taxable trade or an option to buy)
Unlike stocks, however, wash sale restrictions DO NOT apply to cryptocurrencies, at least as of 2021. That means that investors can take advantage of downswings in cryptocurrencies to offset their gains without worrying about the timing of each sale. This can be a huge tax-saving measure if done correctly.
Reporting of Crypto Held Offshore
Although you did not have to disclose offshore crypto holdings previously, the Financial Crimes Enforcement Network (FinCEN) issued a notice in late 2020 that the Treasury plans to require this type of disclosure if you hold more than $10,000 in offshore accounts. Failing to report properly can result in jail time and penalties that can be as high as 50% of the value of the account.
What is a Taxable Event for Cryptocurrency?
Cryptocurrency taxable events include buying and selling as well as exchanging and transferring. Even using cryptocurrency to purchase goods and services is considered a taxable event. Peer-to-peer exchanges are taxed as well.
Receiving cryptocurrency as payment will trigger income taxes, too. This includes receiving cryptocurrency from:
- Airdrops
- Decentralized finance lending
- Block rewards (crypto mining income)
- Staking and liquidity pools
You may be surprised to learn just how extensive a taxable event for cryptocurrency can be.
What You Need to Know About Special Cases: Losses Due to Ponzi Schemes and Theft
Unfortunately, those who hold cryptocurrency are often more susceptible to losses because of certain activities, including scams, thefts, and Ponzi schemes. In fact, in 2019 alone, there were reported $4.9 billion in losses because of crime-related issues.
Thankfully, however, the IRS has implemented specific rules for those who have been victims of Ponzi schemes and other theft losses. Instead of only deducting capital losses, those who have been victims of theft can deduct all of their losses related to the theft. The deduction is also not limited to 10% of your adjusted gross income like some other deductions, but it is taken as an itemized deduction on your income taxes. The loss can be carried forward for ten years and carried back for three years (often resulting in a refund on prior tax obligations).
The IRS Crack Down on Non-Reporters
In 2020, the IRS created the first Form 1040 that specifically asks about income related to cryptocurrency. It also created the Office of Fraud Enforcement in 2020, with a new 2021 division that uses an investigative team called “Operation Hidden Treasure” to identify individuals who are not reporting income from cryptocurrencies.
If you want more information about how cryptocurrency is taxed, or have questions about i on your taxes and finances, send us an email at Info@ZagmoutCPAs.com, or call us at (312) 239-3716.
To learn more, visit Zagmout & Company CPAs at www.zagmoutcpas.com.
