Cryptocurrency Tax Guide Summary
- Cryptocurrency Taxes 101
- Taxable and non-taxable crypto events
- Calculating cryptocurrency tax
- Accounting methods for cryptocurrency
- Capital Gains and Cost Basis
- FIFO, LIFO and HILO accounting methods
- Reporting cryptocurrency on your taxes
- As ordinary income
- As capital gains or losses
- Cryptocurrency income tax rates and events
- DeFi (Decentralized Finance). Overview and how transactions are taxed
- DeFi Liquidity Pools and Providers
- NFTs (Non-fungible tokens) tax guidance
- Cryptocurrency exchanges and challenges with tax forms
- Crypto tax record keeping
- IRS and cryptocurrency tax tracking
- Lowering tax liability: tax loss harvesting and long-term capital gains
- Other cryptocurrency transaction types and tax treatments
- Crypto interest income treatment
- Crypto margin trading taxes
- ICOs (Initial Coin Offerings)
- Hard Forks / Soft Forks
- Airdrop tax treatment
- Crypto donations and gifts
- Crypto as Tax Investment – not obligation
- DAP Trusts (Digital Asset Protection Trusts) for crypto estate planning
This article provides an overview of U.S. cryptocurrency tax implications, what is needed to help stay compliant and the accounting methods and forms used for optimal returns.
Cryptocurrency Taxes 101
In the U.S., cryptocurrencies like Bitcoin, Ethereum and others, are treated as property for tax purposes and fall into standard capital gains or ordinary income categories. However, new advancements in cryptocurrency decentralization create some gray areas which the IRS has yet to address and senior US administration directives are underway to coordinate regulation standards between key agencies.
As with traditional types of property like real-estate, bonds and stocks, capital gains and capital losses apply to your cryptocurrency investments when you trade or sell or cryptocurrencies. Capital gain and loss percentages are based on income tax brackets and whether the capital gain is short term or long term.
Aside from trading, selling and buying, “earned” cryptocurrencies such as: mining; airdrops; staking; job / work compensation; referrals or lending based interest gains are treated as income based on the US Dollar rate of crypto earnings for tax purposes.
Cryptocurrency Taxable Events
Tax reporting is required when your crypto investing activity triggers a taxable event (when income is generated). As defined by IRS virtual currency guidance, taxable events for cryptocurrency include:
Earning cryptocurrency as income or referral rewards
Spending cryptocurrency to purchase goods or services
Trading one cryptocurrency type for another (example: Bitcoin for Ethereum)
Trading crypto to traditional currency
Non-taxable Cryptocurrency Events
Buying and holding a crypto currency such as Litecoin, Bitcoin, Ethereum as examples.
Investing into an ICO or initial coin offering.
Transferring cryptocurrency from one wallet to another that is owned by the same individual or business.
Calculating Cryptocurrency Taxes
To determine capital gains and losses from each crypto disposal, sale or trade, the following formula is used:
Fair Market Value – Cost Basis = Capital Gain/Loss
Fair market value is defined as the price an asset would sell for on the open market. In the case of cryptocurrency, this price is usually applied in USD values.
Cost basis is defined as how much money has been used to purchase property (i.e. total costs) and includes not only the purchase price but also all of the other costs associated with purchasing cryptocurrency (fees and other related costs).
For example if you buy 1 Bitcoin for $500, your cost basis is $500 per Bitcoin. If you sell or trade it when it hits $800, the $800 is the FMV or fair market value. Using the formula above:
$800 (Fair Market Value) – $500 (Cost Basis) = $300 Capital Gain
Which Method Is The Best Costing Method?
FIFO (First in, first out) is used most often because it is the most conservative method and requires the least amount of bookkeeping.
LIFO (Last in, first out) can extend the holding period of an asset, thereby avoiding the higher short-term capital gains rate.
HIFO (Highest in, first out) can help decrease taxable income since it can help realize the highest cost of goods sold.
Applying LIFO or HIFO can assist in tax savings, however, these methods can only be used if detailed crypto transaction records have been kept.
Note that, per IRS guidance, individuals and organizations can use LIFO and HIFO if the following records are maintained:
- Date and time each asset was acquired.
- Cost basis and FMV of each asset at the time acquired.
- Date and time each asset was sold, exchanged or disposed of.
- The FMV of each asset when sold, exchanged, or disposed of, and the amount of money or the value of people received for each unit.
Note that some cryptocurrency exchanges, such as Coinbase, only offer their users HIFO based tax record exports and those reports may need to be converted to FIFO or LIFO methods as appropriate. This translation process from one method to another can impact tax returns, be complicated and likely requires professional assistance. Millan and Company offers a comprehensive cryptocurrency bookkeeping service to assist in tax saving strategies for our clients.
Reporting Crypto On Your Taxes
Ordinary income is not reported on IRS Form 8949. Instead, the income earned from jobs, staking, mining or interest accounts are reported on specific schedules of Form 1040 based on the varying circumstances below.
Schedule 1 – Is used for crypto earned from forks, airdrops or other cryptocurrency wages and hobby income or “other income” on Form 1040.
Schedule B – Staking proceeds or interest income from cryptocurrency lending is typically reported on Schedule B of Form 1040.
Schedule C – Crypto earned as self-employment income, business entity or running a cryptocurrency mining operation needs to be documented on Schedule C of Form 1040.
How Much Tax Do You Pay On Your Crypto?
The holding period of crypto assets (short term vs. long term) and income tax brackets determine how much tax and percentage of tax is owed on crypto income.
Short-term capital gains tax term
If held for less than 12 months, short-term capital gains apply to any assets.
Short term capital gains are treated as normal income for tax purposes and are added to the personal income tax bracket schedule. This includes staking rewards, airdrops, and interest earnings.
Long-term capital gains tax term
Crypto assets held for 12 months or more are currently treated as long-term capital gains and are taxed at a lower percentage than short-term capital gains.