For crypto enthusiasts, crypto taxation is not the most thrilling aspect of investing in cryptocurrency, however, understanding how the taxation of digital currencies works is crucial. Despite their recent emergence, the Internal Revenue Service (IRS) is diligently working to ensure compliance with crypto tax regulations. There are several scenarios in which you might find yourself liable to pay taxes on your crypto holdings, including exchanging one cryptocurrency for another, which is considered a taxable event.

Profits derived from other digital assets, like non-fungible tokens (NFTs), are also subject to taxation. Failing to maintain accurate records can complicate the process of assessing your profit and loss during tax season. Furthermore, even an unintentional failure to pay crypto taxes can result in substantial penalties. 

Key Takeaways

• The Internal Revenue Service (IRS) considers cryptocurrency property, meaning that purchasing, selling, or exchanging it qualifies as a taxable event and typically leads to a capital gain or loss.
• Income earned from cryptocurrency activities is subject to taxation as ordinary income.
• You must disclose these taxable events on your tax return using various forms.
• Maintaining detailed records of your transactions is essential so that you can accurately report all your crypto-related activities to the IRS throughout the year.
• Let’s assume you sell cryptocurrency and generate a profit. In that case, you are liable to pay capital gains taxes on that profit, similar to how you would with a stock investment.
• Utilizing cryptocurrency for purchasing goods or services requires you to pay taxes on the increase in value between the price you initially paid for the crypto and its value at the time of spending.
• When you accept cryptocurrency as payment for goods or services, it is necessary to report it as business income.

What is Crypto Capital Gains Tax?

A capital gain refers to the earnings obtained by selling an asset at a higher price than its original cost. Assets subject to capital gains taxes encompass a wide range, including real estate, businesses, vehicles, stocks, bonds, mutual funds, and various investment vehicles.

Selling any of these assets can result in a taxable event, necessitating the reporting of your gains to the IRS. Similar regulations apply to cryptocurrencies. According to the IRS, Bitcoin, Ethereum, Dogecoin, and other digital currencies are classified as assets for tax purposes.

What is Crypto Income Tax?

Not all gains in cryptocurrency originate from trading and capital appreciation, which means there is an entirely different realm of crypto taxes you need to keep in mind. You may find yourself earning digital coins through gaming endeavors or stumble upon them unexpectedly in your wallet. Such profits are subjected to taxation as ordinary income, falling into the same category as wages earned from a conventional job. Regarding crypto income, its tax as regular income is determined based on its fair market value at the time of receipt by the taxpayer. Below are the most prevalent instances that qualify as crypto income:

• Acquiring crypto as compensation for rendering a service.
• Engaging in crypto mining and earning rewards.
• Participating in crypto staking and reaping rewards.
• Providing crypto loans and receiving interest payments.

Taxation principles for cryptocurrencies resemble those of stocks, as they are considered property rather than currency for tax purposes. Regrettably, this classification implies that most crypto transactions result in what we call a taxable event.

A taxable event signifies an occurrence that necessitates reporting. Since Bitcoin and other digital currencies are considered property from a tax standpoint, individuals may be subject to two possible taxes – Income Tax or Capital Gains Tax. The specific type of cryptocurrency tax applicable to you depends on the nature of your crypto transactions.

What is the Cryptocurrency Tax Rate?

Short-term capital gains and crypto income can be subject to taxes of up to 37%, while long-term capital gains may incur taxes ranging from 0% to 20%. However, NFTs classified as collectibles might face a higher tax rate of 28%. The tax amount applicable to your cryptocurrency activities in the United States is determined by factors such as your earnings, the nature of the transaction, and the duration of asset ownership.

Short Term Tax Rate

When you retain ownership of a digital asset for one year or less, any earnings generated from it will fall under the category of short-term capital gains. These gains are subject to taxation at the same rate as your ordinary income, which is determined based on your total earnings.

Long-Term Crypto Tax Rate

When you maintain cryptocurrency ownership for a duration exceeding one year, any earnings you generate will be subject to the favorable long-term capital gains rate. The specific rate applicable to you is still contingent on your overall income. Generally, long-term capital gains rates are lower compared to those for short-term gains. As stated in the cryptocurrency tax FAQs provided by the IRS, the holding period commences the day following the asset’s receipt. The asset’s cost basis is calculated by adding its purchase price to any relevant fees incurred.

When is Cryptocurrency Taxed?

Simply owning cryptocurrencies does not automatically incur taxes; you are not obliged to pay taxes solely for holding them. However, the Internal Revenue Service (IRS) classifies cryptocurrencies as property for tax considerations, which entails the following:

• Taxes are applicable when you sell or utilize your cryptocurrency in a transaction. This is because such actions can trigger capital gains or losses if there has been a change in its market value.
• If you receive cryptocurrencies as payment for business-related purposes, they are subject to taxation as business income.

How Much Would You Pay on Crypto Capital Gains?

Taxation on cryptocurrency follows the same rates as other forms of capital gains. Regarding businesses, the capital gains tax rates align with the standard corporate income tax rate. However, as is often the case in income taxation, things can become intricate. Reporting capital gains tax on cryptocurrency depends on factors such as the type of business entity and whether the gains are categorized as short-term or long-term. The taxable events that trigger capital gains include:

• Selling cryptocurrency for USD or fiat currency
• Exchanging one form of cryptocurrency for another
• Using cryptocurrency to pay for goods and services

Calculating Crypto Gains: HIFO, LIFO, FiFO

If you are a cryptocurrency investor who has made multiple purchases over time, each of your purchases constitutes a separate lot. When the time comes to sell, the profits or losses incurred will be contingent upon the specific lot you sell. Various accounting methods exist to determine the measurement of gains, namely FIFO, LIFO, and HIFO. Here’s an explanation of what these acronyms represent:

• FIFO (first in, first out): This method calculates your taxes by assuming that the first unit you purchased is the first unit you sell.
• LIFO (last in, first out): With LIFO, your taxes are calculated as if the most recently acquired unit is the first one sold.
• HIFO (highest in, first out): When using the HIFO approach, your taxes are determined based on the cryptocurrency unit, with the highest purchase price being the one sold first.

Employing different accounting methods can significantly reduce your tax obligations. The most suitable accounting approach may vary depending on prevailing market conditions.

How to Determine if You Owe Crypto Taxes

You have tax obligations related to cryptocurrencies if you spend them, and their value has appreciated since your acquisition. Here are the various types of taxable events that apply to cryptocurrency transactions:

• Selling cryptocurrency in exchange for fiat currency.
• Using cryptocurrency to make purchases of goods or services.
• Trading one type of cryptocurrency for another.

However, these events are only taxable if the value of your crypto has indeed increased. To determine whether you owe crypto taxes, consider the cost basis, which refers to the total amount you paid to acquire the crypto. Then, you compare this with the sales price or proceeds when you utilize the crypto. Let’s assume you had previously bought one Bitcoin for $20,000. Here are some examples of taxable events:

• If you sell one Bitcoin for $50,000, you would report gains of $30,000.
• If you use one Bitcoin to buy a car valued at $45,000, you would report gains of $25,000.
• If you trade one Bitcoin for another cryptocurrency worth $60,000, you would report gains of $40,000.

Trading between different cryptocurrencies adds complexity to crypto taxes. Each crypto trade is considered a taxable event. When you exchange one cryptocurrency for another, you must report any gains in U.S. dollars on your tax return. Keeping track of the profits or losses in U.S. dollars every time you engage in crypto trades is vital. This way, you can accurately report your crypto gains or losses.

Alternatively, investing in cryptocurrency stocks could simplify tracking profits and losses compared to buying and selling individual coins. NFT taxes operate in the same manner as crypto taxes. If you realize a profit from selling an NFT, you are required to pay taxes on those gains. It is worth noting that if you mint an NFT and pay a gas fee in cryptocurrency, this is considered a purchase of service using your crypto, making it a taxable event. If the value of the cryptocurrency you used for the gas fee has increased since your acquisition of it, you would owe taxes on the gains made.

Taxable Events for Cryptocurrency

There are several events involving cryptocurrency that are subject to taxation:

• Swapping cryptocurrency for fiat currency, which refers to government-issued money.
• Using cryptocurrency as a means of payment for goods, services, or property.
• Trading one type of cryptocurrency for another.
• Receiving newly mined or forked cryptocurrencies.

These events can trigger tax obligations and should be considered when managing your cryptocurrency activities.

What if you Lost Money on Crypto During the Tax Year?

One major question people ask is, “What happens if you end up selling your cryptocurrency for a price lower than its initial purchase price?” Similar to other investments, if you sell your crypto at a loss, meaning its value has decreased by the time of sale, trade, or expenditure, you can claim a capital loss.

Losses aren’t entirely negative, as they can help lower your overall tax liability by offsetting other sources of income. For instance, if you profit from one cryptocurrency transaction but incur losses in other trades, you can utilize those losses to offset your gains within the limitations established by the IRS. Additionally, there are different strategies you can employ to minimize your tax burden.

One such strategy is tax-loss harvesting, where you intentionally sell a portion of your crypto at a loss to offset the gains you’ve obtained from other sales. By implementing this approach, you can leverage your losses to counterbalance the profits made from other cryptocurrencies or stocks, thereby reducing the amount of taxes you owe.

Different Types of Crypto Transactions That Are Tax-Free

There are certain situations where you won’t be liable to pay taxes on your cryptocurrency:

• Purchasing cryptocurrency using fiat currency.
• Holding onto your cryptocurrency without engaging in any transactions.
• Transferring your cryptocurrency between your wallets.
• Giving cryptocurrency as a gift, as long as it doesn’t exceed the lifetime gift limit.
• Donating cryptocurrency to a charitable organization, which can be tax deductible. However, you may require a qualified appraisal if the donation amount exceeds $5,000.
• Creating a non-fungible token (NFT).

How Do Crypto Tax Brackets Work?

The tax rate for your cryptocurrency varies depending on whether you held the assets for short-term or long-term capital gains. Here is a breakdown based on different income levels to help you determine your crypto tax bracket and rate for the 2023 tax year (applicable to U.S. taxpayers).

Short-Term Capital Gains Tax for Crypto

Currently, the IRS considers cryptocurrency to be an asset rather than cash, meaning that profits from crypto sales are categorized as capital gains rather than income. The tax implications of capital gains depend on how long you held the asset before selling it. Expatriates who have owned their cryptocurrency for less than a year before selling it may be subject to short-term capital gains tax.

In the United States, short-term capital gains are taxed based on your regular income tax bracket. Therefore, if you find yourself in a higher tax bracket, even after taking advantage of all the available tax benefits for U.S. citizens living abroad, your cryptocurrency gains could potentially be subject to a significant tax rate of up to 37%, which can be pretty substantial.

Long-Term Capital Gains Tax for Crypto

By holding onto your cryptocurrencies for more than a year before selling them, you can reduce your tax obligations, even if you reside outside your home country. Unlike capital gains from cryptocurrency, which are typically taxed according to your regular tax bracket, long-term capital gains tax follows a graduated scale that is adjusted periodically.

For instance, in 2022, the maximum tax rate for long-term capital gains from cryptocurrency was 20%. The tax rate may range from 0% to 15%, depending on your income and filing status. However, you must hold the assets for over a year to qualify for long-term capital gains tax treatment on your cryptocurrency gains. This can be challenging, remarkably, if market trends suggest it may be advantageous to cash out or exchange for another cryptocurrency.

It is essential to consult with a Certified Public Accountant (CPA) who specializes in assisting American expatriates, as they can guide the best course of action to minimize your tax liability on crypto gains.

Charitable Contributions and Gifts in Crypto

When you itemize your portfolio, you can donate cryptocurrency to eligible charitable organizations and benefit from a tax deduction. Generally, you can deduct the fair market value of your cryptocurrency at the time of the donation, and you are not required to pay capital gains taxes on the donated amount.

Cryptocurrency donations to charities are considered non-cash contributions. If you plan to claim a deduction of $250 or more for the virtual currency donation, obtaining a written acknowledgment from the charitable organization to document your contribution is advisable. This acknowledgment can assist you in complying with the requirements for claiming the deduction.

Tax Saving Strategies for Cryptocurrency

To minimize your tax obligations, there are several strategies you can employ, and understanding the distinction between long-term and short-term capital gains is just one of them. Here are some popular approaches to consider:

• Hold cryptocurrency for more than a year: You can benefit from the lower tax rate applied to long-term capital gains.
• Offset tax losses: Implementing tax loss harvesting techniques involves selling an asset at a loss to offset capital gains. Investors can then repurchase a similar investment at a lower price, effectively replacing it in their portfolio for potential future improvements.
• Optimize your accounting method: Selecting the most suitable method—whether it’s FIFO, LIFO, or HIFO—can yield savings based on holding periods and prevailing market conditions.
• Invest in tax-advantaged accounts: By placing your cryptocurrency investments in an IRA, 401(k), or other tax-advantaged investment vehicles, you can defer or avoid capital gains taxes.

By incorporating these strategies into your tax planning, you can work towards reducing your overall tax burden and maximizing your financial gains.

Cryptocurrency Tax for Crypto Mining

Mining cryptocurrency comes with its own set of rules. Miners play a crucial role in verifying and adding transactions to the blockchain, earning rewards in cryptocurrency for their efforts. However, the tax treatment of these rewards differs depending on the circumstances. 

For individual miners, the compensation they receive is considered ordinary income and subject to taxation. This means they must report it as part of their overall income. However, if mining is conducted as part of a business enterprise, the rewards are treated as business income. In such cases, miners can deduct eligible expenses incurred during their mining operations, including costs associated with mining hardware and electricity.

Miners must understand the distinction between personal mining activities and mining conducted as a business. By accurately reporting their earnings and expenses, miners can ensure compliance with tax regulations while optimizing their tax situation within the guidelines provided.

What About DeFi? 

Engaging in decentralized finance (DeFi) introduces various intricate tax considerations. While earning interest on DeFi loans may appear straightforward, the specific tax implications hinge upon the DeFi platforms’ intricacies. This is why understanding the structure and operations of the particular DeFi platform(s) you use is crucial.

For instance, receiving protocol tokens or placeholder tokens in exchange for Ethereum (ETH) can be deemed a taxable event, falling under the category of a crypto-to-crypto swap. Each transaction within the DeFi ecosystem must be carefully evaluated to determine its tax implications and ensure compliance with applicable regulations. It’s advisable to consult with a tax professional or advisor specializing in cryptocurrency taxation to navigate the complexities of DeFi taxation effectively.

What Happens if You Don’t Report Cryptocurrency on Taxes?

The IRS treats cryptocurrencies differently from traditional fiat currencies such as the US dollar or the Euro. Instead, cryptocurrencies are classified as digital assets. As a result, they are subject to capital gains taxation, similar to other capital assets like stocks, real estate, and bonds. Any cryptocurrency trading you have engaged in during the previous year must be disclosed on your tax return. Failure to do so can lead to civil and criminal consequences for not reporting capital gains.

Some individuals have believed that the anonymous and decentralized nature of blockchains would shield their crypto transactions from government scrutiny. However, numerous IRS audits and prosecutions have demonstrated that this is not the case. Blockchains function as decentralized public ledgers that anyone can access. All trading activities can be traced and identified once a digital wallet’s address is linked to an individual or business.

It’s essential to understand that cryptocurrency trades are not hidden from the government, and compliance with tax reporting obligations is necessary to avoid potential legal repercussions.

The Bottom Line About Crypto Capital Gains and Tax Rates

Navigating crypto taxes can be perplexing, and ensuring accurate reporting and payment of the required taxes is crucial. The IRS categorizes cryptocurrency as a digital asset or property, meaning that it triggers a taxable event whenever you sell or exchange it. This even includes using crypto to purchase goods or services.

In most situations, cryptocurrencies are subject to capital gains taxes, either as long-term or short-term gains. However, there are instances where crypto is treated as income. It’s essential to diligently track all crypto transactions to avoid unpleasant surprises when tax season arrives.