When it comes to investing in cryptocurrencies like Bitcoin and Euthereum, it’s common to think about the massive gains you can get.
And as long as Bitcoin continues mooning to an all-time-highs, we don’t blame you.
But, you should also consider the possibility of paying taxes when you sell your cryptocurrency.
That’s where we come in. We’ve done the research for you and this will be the only article you need to understand cryptocurrency taxes.
So let’s dive in!
How Do Cryptocurrency Taxes Work?
In general, if you sell or exchange your cryptocurrency, it is a taxable event.
This includes sales or exchanges for fiat, goods, services, or other cryptocurrencies.
Through the eyes of the IRS, cryptocurrency is viewed as a capital asset when sold for profit and subject to capital gains tax.
We’ll unpack that with an example so stick with us.
So let’s say someone really wants an Audi E-tron.
And that she wants to buy the Audi E-tron using bitcoin she bought for $5,000, which is now worth $60,000.
She has a couple of options:
- First, she could sell her cryptocurrency for dollars and purchase the car in cash.
- Second, she could purchase the Audi outright with her bitcoin.
- Third, she could exchange her bitcoin for another cryptocurrency like Ethereum and purchase the car with Ethereum.
So, which option do you think is best?
You might have your opinion on what option is easiest, but all three options will result in a $55,000 capital gain.
Because she sold her Bitcoin at a profit, in exchange for something else.
Remember, whenever you sell or exchange your cryptocurrency for more than you bought it for, it will be subject to capital gains tax.
Now, if you happened to sell or exchange your cryptocurrency for less than what you bought it for, you have a capital loss.
Capital losses are not taxed and may help lower your tax liability by offsetting a portion of your income.
How Much Will You Pay in Cryptocurrency Taxes?
How much you pay in cryptocurrency taxes depends on how long you’ve held it, whether you sold for a loss or gain, and your total yearly income.
If you held your cryptocurrency for less than a year, profits are taxed as regular income and are known as short-term capital gains.
If you held your cryptocurrency for more than a year, profits are taxed at long-term capital gains rates which are typically lower than income tax rates.
Payment via Cryptocurrency
The truth is this: If you are paid in cryptocurrency for work performed, you must pay taxes on it.
In fact, payments to you in exchange for work are taxed as ordinary income and may be subject to self-employment taxes if you are self-employed.
Additionally, if you hold the cryptocurrency and later sell it, profits will be taxed as a capital gain.
This also applies to cryptocurrency miners. Miners must report all cryptocurrency income derived from mining activities.
Cryptocurrency Losses from Hacks or Other Thefts
If you are the victim of cryptocurrency scams, loss, or theft, you can report the missing amount as an investment loss.
The loss may help lower your tax liability by offsetting a portion of your income.
How to File Cryptocurrency Taxes
The IRS is closely watching investments made in crypto.
At the very top of the new Form 1040, there’s a question about crypto:
At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?
If the answer is yes, here are the steps you need to take:
1. Stay Organized
Be able to find and account for every transaction you make.
Depending on the cryptocurrency exchange you use, this can be a very easy task as they keep records of all transactions including:
- purchase price,
- purchase date,
- sale date,
- sale amount, and
- profit and loss
Additionally, most exchanges will send you a 1099 form before the tax season that will detail all of this information for you.
2. File Taxes Yourself or Hire A Professional
Some cryptocurrency traders execute hundreds of trades a year and others execute half a dozen.
No matter how often you trade, if you feel comfortable accounting for the transactions and completing the proper forms, go ahead and file yourself.
If you are not comfortable accounting for and filing your cryptocurrency taxes, reach out to a reputable accounting firm like LYFE Accounting to make sure it is done correctly.
Best Way To Minimize Cryptocurrency Taxes
If you sold cryptocurrency for a profit, here are three ways to minimize your tax liability.
1. Hold Cryptocurrency for the Long-Term
The easiest way to save on cryptocurrency taxes is to hold your investments for over a year.
When you hold your cryptocurrency for over a year, you can take advantage of long-term capital gain tax rates.
And this can be substantially lower than the taxes for investments held shorter than a year.
That’s because long-term capital gain tax rates have a max tax rate of 20% while short-term capital gains have a max tax rate of 37%.
2. Offset Gains with Losses
You can reduce your capital gain on crypto investments by selling other investments at a loss – this is called tax loss harvesting.
Tax loss harvesting is a good strategy if you know you will be selling an investment for a profit or already sold for a profit within the tax year.
If you have underperforming investments within your portfolio, you can sell them to help minimize your taxes.
The good news is that you don’t have to limit what you plan to sell at a loss to just cryptocurrency. Any capital asset such as stocks can apply.
Generally, if you end up with more than $3,000 in losses, you can carry the remainder to future tax years and tax gains.
3. Wait For A Lower Tax Bracket
Another amazing strategy you can use to lower your tax liability is to sell your cryptocurrency when you know you will end up in a lower tax bracket.
The taxes you pay on capital gains are partly based on your income.
And if you can time the sale of your investments during a period with lower income, you could reduce your tax liability substantially.
There you have it – a complete guide to cryptocurrency taxes!
Remember, if you need help with preparing or filing your cryptocurrency taxes, you can always choose to hire our reliable CPA tax services.
Contact us today at 470-240-1437 to get started.