The IRS views cryptocurrency transactions as investments similar to stock trading, making the gains from cryptocurrency exchange taxable if exchanged for another coin or cash or earned through staking mining or airdrop.
As a financial advisor, you can assist clients with managing their crypto taxes through either general guidance or specific advice from tax or other specialists. Explore crypto taxes from its inception all the way to completion.
Taxes on Gains
When selling crypto, capital gains (or losses) must be reported based on the sale price compared to your original purchase cost (referred to as your “cost basis”). This calculation helps ensure you accurately report cryptocurrency tax liabilities at tax time.
Exchange of cryptocurrency for cash constitutes a taxable event, subject to both short-term and long-term capital gains taxes depending on how long you held onto it prior to selling it. Swapping crypto for another cryptocurrency constitutes capital transaction taxes as well.
Receivers of cryptocurrency compensation or donations should consider it personal investment income that must be taxed at the same rate as any other forms of earned income. Miners/stakers of cryptocurrencies must pay self-employment tax on any earnings recognized.
Taxes on Losses
As with stock trading, cryptocurrency sales profits are taxed as capital gains or losses. Your purchase price of your crypto assets becomes its cost basis; when selling them off later on, the IRS calculates any taxable capital gain or loss based on both price and cost basis. Tracking all your buy, sell and exchange transactions may prove challenging when using crypto debit cards for purchases like coffee or lunch; tax-loss harvesting offers one solution that helps offset gains through strategic selling at a loss to offset gains.
Your cryptocurrency becomes subject to tax when you either spend it or it depreciates while in your holdings, and the IRS taxes it as capital gains with rates up to 37% depending on your filing status and income level. To minimize tax burden, using either the FIFO (first-in, first-out) or Specific Identification methods of tracking cost basis could significantly lower taxes; these strategies should be discussed with a qualified tax advisor before taking any decisions regarding them.
Taxes on Borrowing
Cryptocurrency is considered property by the IRS and so standard capital gains tax rules apply when disposing of cryptocurrency investments. When disposing of your crypto, you’ll owe either realized capital gain or loss depending on its price movement since its initial purchase – keeping track of cost basis and sale prices is crucial to ensure accurate tax calculations.
However, lending and borrowing cryptocurrency are tax-exempt events. Furthermore, any interest expense from DeFi platforms that requires you to deposit cryptocurrency as collateral for loans made out on that platform does not count towards taxes as long as those proceeds are used for business purposes.
However, if you use loan proceeds to acquire more cryptocurrency and then sell those assets for a profit later on, this will count as realized gains and may require capital gains tax payments. To avoid this fateful scenario altogether, consult with an experienced crypto tax advisor and create an effective crypto asset strategy together.
Taxes on Trading
As with stocks, cryptocurrency falls under capital gains tax rules when traded for cash or another cryptocurrency asset. When doing so, gains and losses must be reported on Form 8949 to comply with tax reporting obligations.
When selling cryptocurrency, the IRS considers both its original purchase price and sale price as factors in taxing you on any difference between them. This tax liability could potentially range anywhere from 10%-22% of that difference depending on its severity.
An essential factor when calculating cryptocurrency costs is understanding their path from purchase to exchange and storage. This can be a complex process since most individuals purchase and trade multiple cryptos across various exchanges and wallets.
DeFi protocols pose an especially tough challenge to users, since they involve moving crypto between exchanges without altering ownership – this makes generating an accurate tax report almost impossible, since many exchanges don’t provide you with a list of your purchases or sales along with their cost basis.