The cryptocurrency market keeps growing, as more and more people discover the value of investing. In addition to Bitcoin, many other currencies are becoming popular ways for those with the know-how to cash in on crypto.
However, when tax season rolls around, things can get confusing even for a cryptocurrency expert. How do cryptocurrency taxes work? That question will be on a lot of investors' minds as the April tax deadline draws closer.
We can help. In this guide, we'll give you the basics of cryptocurrency taxes, so you can avoid IRS trouble. Keep reading before you start filling out those tax forms!
Do You Need to Pay Cryptocurrency Taxes?
You don't always need to pay taxes on the cryptocurrencies you own. Instead, there are some specific situations when you'll need to pay taxes.
Legally, cryptocurrency is seen as an investment or asset, not a true currency. Luckily, the IRS makes it pretty clear how you're expected to pay taxes on your assets. However, since cryptocurrencies are different from stocks and other types of assets, things can still get complicated.
The two main times you need to pay cryptocurrency taxes is when you purchase or trade cryptos. For example, you might decide to cash out your crypto to buy something. In these cases, you'll need to pay certain kinds of taxes, depending on exactly how the transaction played out.
If you trade cryptos, the profits or losses affect your taxes just like stock trades do. You'll need to make a capital gains tax calculation to account for your losses or gains, and pay the correct taxes on them.
Cryptocurrency and Taxes FAQs
Because cryptocurrency still functions with many grey areas, you'll probably run into some questions when you try to do your taxes. Let's take a look at some of the most common ones to make tax time easier.
How Do I Calculate Capital Gains?
Since cryptocurrency taxes usually involve capital gains calculations, here's a quick look at how that works.
Basically, you'll subtract your cost basis from the fair market price to get your capital gains. To get the fair market price, just use the value of your crypto at the time you sold it. The cost basis is the total amount you paid for it, including any extra fees or costs required for the purchase.
However, you'll also need to break down your capital gains by short- and long-term. Your short-term capital gains include cryptos that you bought and sold in the same year. Long-term capital gains apply to those that you sold more than a year after the purchase.
You'll pay capital gains taxes according to your individual tax bracket, but keep in mind that the rates for long-term gains tend to be lower. This gives you an incentive to keep your crypto assets for longer.
What Happens When I Exchange Cryptocurrencies?
Exchanging one crypto for another also functions as a capital gain or loss event. You'll need to look at your profits or losses from the crypto you exchanged and account for them in your taxes, just like you would for a sale.
What if I Cash Out -- But Not for Dollars?
When you cash out your crypto to buy a car, hire a freelancer, or do anything else, unfortunately, the transaction still gets taxed. In both cases, the IRS sees the transaction as a "sale," even though no actual cash was involved.
The same rule applies if you barter with stock or other assets. But if you make a charitable donation using crypto, you won't need to pay capital gains taxes on that transaction. You also get a tax deduction for that donation.
Do I Pay Taxes on Mined Coins?
When you mine Bitcoins or other cryptos, it's considered income. You may not need to pay taxes on it right away, but you need to know the fair market value on the day you mined it. You'll need that information to calculate your capital gains tax if you exchange or sell it.
How Do Forks Affect My Taxes?
The "forks" that create new cryptos often mean you'll pay more in taxes, unfortunately.
The IRS holds that "treasure trove" money that you find is still taxable, so there's no profit loophole that you can exploit here. You'll need to report the fair market value of any cryptos that you get because of a fork, as it's considered taxable income.
Can I Use the 1031 Like-Kind Exchange?
When you trade from one crypto to another, it doesn't count as a 1031 Like-Kind exchange, so it's still taxable. While at one time you could use 1031 for crypto, new tax reforms have since disallowed these claims.
How Can I Make Cryptocurrency Taxes Easier?
As you can see, paying your cryptocurrency taxes quickly gets complicated.
To make it easier on yourself, start by keeping careful records of all your crypto transactions. Record values in dollars, since you'll need to convert them for your taxes anyway.
If you haven't been keeping records, you'll need to pull up the information for all your old transactions, but the sooner you start the better. Make sure to record the dates of all your transactions, as well as how much you paid or received.
Your exchange also might offer tax reporting services, especially if you invest a lot. Make sure to explore this option, because it could save you tons of time.
Now You're Ready to Pay Cryptocurrency Taxes
With this guide, you're ready to handle the basics of paying your cryptocurrency taxes. Although the crypto tax world is complex, careful record keeping and understanding the tax rules that affect you make everything easier.
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