Cryptocurrency was first introduced to the world about a decade ago. It had a few attractive qualities that attracted a limited number of people.
The first thing to note is that the currency is decentralized. It is not controlled by the central bank and it’s not issued or controlled by a bank like fiat currencies such as the U.S. Dollar or Euro. Second, the transactions are quick and easy. This is because the transactions are between individuals and not institutions. Third, transactions involving crypto are cheaper because there’s no middleman to collect a fee.
Taxes and Cryptocurrencies
But there was another quality to cryptocurrencies that seemed particularly…intriguing. Because cryptocurrency isn’t regulated, and it doesn’t go through the usual bureaucratic process, this might just be the best payment system for avoiding income taxes.
Remaining Time: -18.53 FullscreenCertified Financial Planner Answers Common Questions
This was at least the thought process of the time. It had some merit. Cryptos were just a blip on the wall in the financial world. The IRS, in particular, paid them little attention.
It’s been a while since then, at least when it comes to modern investing. A lot has changed. Cryptos are now mainstream and have gained in value and popularity. The major financial media now regularly track and report Bitcoin prices.
The IRS is now paying attention to cryptocurrency. You’ll want to know the tax implications of your cryptocurrency transactions.
Although the IRS’s treatment of cryptos has not yet been fully developed, it is now clear that he is tracking crypto activity. To be successful as a crypto investor, you need to educate yourself and play by the rules.
What are these rules?
The IRS is still working on strategies to handle crypto transactions. Before we begin, let me tell you that I am a certified financial advisor, and not a CPA, tax attorney, or CPA. This means that I am not an expert in taxes. You should consult a professional tax advisor with any questions about your own personal situation.
I will do my best, to the extent that we know, to explain what we currently know about IRS treatment for crypto transactions.
Let’s cover seven common cryptocurrency questions.
7 Common Cryptocurrency tax questions
1. Do I have to report my cryptocurrency transactions to the IRS?
I will get straight to the point – absolutely! Even the IRS is taking action to target undeclared crypto income. The IRS launched a program called Operation Hidden Treasure to track down crypto activity. They are also warning taxpayers about the fact that crypto transactions do not remain anonymous.You can trade crypto on an IRS-compliant broker. Robinhood You’ll get a 1099B from your broker reporting on your crypto activity.
Let’s say that you use an exchange which is not IRS-compliant and does not provide a Form 1099-B. It is important to know that your tax obligations are not eliminated. Keep your own records and notify the IRS of any crypto transactions.
You’ll be required to pay tax and report any gains made on the sale cryptocurrency, just as you would on the sale securities like stocks and bonds. You’ll have to report them on your tax returns. When you file your personal income tax return, you can include them in Schedule C, Capital Gains & Losses.
In Question #3, I’ll tell you how much tax you will owe for your crypto capital gains.
2. Does it matter if I keep my cryptocurrency and don’t try to sell it?
No, you won’t be paying taxes because gains are not realized until the asset is sold. The only thing that happened was an increase in your crypto’s market value, which isn’t taxable.
3. What is the tax I will owe if I make a profit?Answering this question depends on whether or not the gain was a result of a capital gain that occurred over a longer period. Gains on the sale or other assets are short-term capital gains if they occur within a year. Long-term capital gain is a capital gain that occurs over a period of more than one year.
It’s important to know that the tax rates on short-term gains is much higher than those for long-term ones.
Long term capital gains are taxed at a maximum of 20% if the income exceeds $441,450 for singles or $496600 for married couples filing jointly. If your annual income is below $80,000 you could owe no capital gains tax.
The ordinary income tax rate applies to short-term capital gains. This can range from 10% up to 37%, depending on your income.
This doesn’t mean that short-term capital gain is a bad thing. You are paying tax on your profit. Tax is calculated based on the highest marginal rate. According to my tax bracket, I’d have to pay 37%. I would rather pay tax and take the loss than to take a profit.
4. What tax treatment will I receive if I lend online cryptocurrency?
Tax-wise, the income you receive from lending cryptocurrency will be treated as interest. It is the same as earning interest on high yield savings accounts. This interest will be reported on your tax return and taxed at the ordinary income tax rate.
5. Can I defer capital gains tax by reinvesting my cryptocurrency gains?
You can defer capital gains by using the IRS’s like-kind exchange provisions. A 1035 exchange is applicable to annuities and life insurance policies, while a 1031 exchange is available for real estate. Either exchange allows you to replace an asset with another asset that is comparable and defer tax until the second asset is sold.
Cryptos are different. Taxes are due on all gains, no matter what you decide to do with them.
6. Does the IRS know what I do with my cryptocurrency?
Big Brother is always on the lookout! The IRS knows that you invested in a crypto exchange even if it is not IRS-compliant. They will know this when you transfer funds from your U.S. account to the exchange.They can tell if you make large or frequent transfers that you are very active in crypto investments. Cryptocurrency has become much less anonymous than it used to be when it was first introduced. The IRS and other government agencies track the activity as it grows in popularity.
7. Do I still have to pay tax if I change my cryptocurrency into another?
You can get this if you trade Bitcoin for Dogecoin, Ethereum or one of the stablecoins.
You buy Bitcoin at $10,000 and it increases to $50,000. Then you exchange your Bitcoins for Ethereum. Unfortunately, is a taxable event.
The IRS sees it as a sale of one crypto for another, even though it is viewed by the crypto world as an exchange.
You will need to declare a gain of $40,000 on your Bitcoin, which is equal to the $50,000 purchase price less your initial $10,000 investment. You’ll have to declare your gain whether you sold the Bitcoin in U.S. Dollars or another cryptocurrency.
Miscellaneous Crypto Tax Questions
As I was answering the questions above I came up with a few others that may be useful in determining how to handle your crypto trades when it comes to tax.
In what order do you sell cryptocurrency when making multiple purchases?
Let’s say, for example, that you purchased Bitcoin at $3,000 and again at $50,000. You decide to sell when the price reaches $60,000 The gain is based on either the $3,000 or $50,000 purchase.
Tax purposes recognize gains on a “first-in-first-out” (FIFO basis). This means that the capital gain must be recognized first on the $3,000 acquisition, which will result in a larger gain of $57,000 ($60,000-$3,000).
A $10,000 capital gain would be generated by selling the $50,000 at $60,000. The gain on the $3,000 would have to be recognized before the $50,000 purchase.
Does the tax treatment of crypto exchanges differ if it is for a stablecoin exchange?
Stablecoins are a form of crypto currency where the value of the coin is linked to the US dollar or another recognized world currency. These coins are called stable because they have a fixed value.
Exchanges of stablecoins for other cryptos are subject to the same rules. The gain from the sale of crypto will need to be recognized at the time you exchange the stablecoin for it.
It doesn’t really matter whether your crypto is exchanged or sold for cash. Gains on crypto you have sold will be taxed.
Does it make a difference if you buy and sell crypto through a broker, like Robinhood that does not have its own digital wallet?
The tax implications of a crypto transaction are the same whether you sell it through a broker, an exchange or even one that is based outside the U.S. All of the above rules will apply.
The main difference between the two is that a broker such as Robinhood will issue you a 1099B because it is based in the US and is therefore US tax-compliant. A crypto exchange that is not compliant will require that your maintain records, and then report all of your transactions using those records.
Does the wash-sale law apply if you sell Bitcoin at a loss in order to lock in the short-term capital gain, and then buy Bitcoin again on another platform before the 30-day period has expired?
The wash-sale regulations do not apply to crypto, as it is considered property rather than a financial instrument.
The wash-sale rules are important to know.
The wash-sale rule: the crypto trader’s best friend
To this point, I have covered the tax implications of cryptocurrency transactions. Cryptocurrency offers a tax saving that is not available anywhere else. The benefit is enormous. It was only after I did more research that I could confirm it.
The wash sale rule is what you can use to save on taxes. If you purchase a security, and its value drops, you may be able to sell it for a loss. You can’t purchase the same security or a similar security within 30 calendar days after the original sale (or 30 calendar days before the initial sale).
The wash-sale rule does not apply to cryptocurrency. Wash-sale laws don’t apply because the IRS classes cryptocurrency as property and not as a financial instrument.
(NOTE: IRS Notice 2014-21 does not specifically exempt cryptocurrency from wash-sale regulations. It defines crypto as a property that is generally interpreted to exclude it from wash-sale regulations.
What are the benefits of cryptocurrency investment?
Bitcoin’s value has dropped in recent months. Say you purchased $50,000 of Bitcoin in March, and it is now worth $30,000 You can sell the Bitcoin today and lock in your $20,000 capital loss.
Capital losses can be deducted from future capital gains. According to IRS regulations, capital losses can be deducted from capital gains.
You can shield up to $20,000 of gains from your investments if you use the proceeds of the Bitcoin sale to buy other cryptocurrencies.
Cryptocurrency volatility creates opportunity. One crypto can go down at any time while another goes up. This wash-sale is great if you feel it’s the right time to switch from one crypto to another. This is a way to create tax-free profits from your losses.
Capital Loss Carryforward
You can still benefit from capital losses even if you don’t have any crypto capital gains.
You can still deduct capital losses up to $3,000 if losses exceed gains. If your losses exceed $3,000 you can carry forward the excess to future tax years and deduct it from income.
You can deduct capital losses up to $3,000 per year if there are no future capital gains.
Tracking Your Cryptocurrency Trades
It’s important to develop a system to track your trading, especially if it is something you do frequently. Personal, I haven’t received a 1099 for any place where I’ve traded cryptos. So tracking and reporting is still a bit of a grey area.
If you trade on an exchange that is not compliant and does not issue Form 1099B, you will need to track your transactions using specialized software.
Last Words of Advice Regarding Cryptos and Taxes
Last but not least, if you are an active trader and have questions about taxes, you should seek the advice of a tax professional.
It is possible to be complicated when discussing cryptos and tax. The IRS has yet to determine how it will treat crypto transactions. New rulings are being issued all the time.
The best people to ask about the newest rules are tax professionals. It will cost money to consult with a tax expert. It’s a small fraction of the thousands in penalties and taxes the IRS could impose if you make an error.