Cryptocurrency, a digital currency based on blockchain technology, is becoming more and more popular with more than 5,000 different cryptocurrencies in circulation. If you own cryptocurrency, like Bitcoin or Ethereum, it is important to understand how it impacts your tax liability every time you buy it, sell it, or mine it.
The IRS treats all cryptocurrency as capital assets and taxes them when they are sold at a profit. If goods or services are purchased with crypto or crypto is exchanged for cash or other cryptocurrency, capital gains taxes are owed if the crypto spent/exchanged has gained value from what it was originally purchased for. If your crypto investment lost value and you exchanged it for cash or another cryptocurrency, you can take the loss in value as a capital loss. Unlike stocks, wash sale rules should not apply to cryptocurrency. Selling or exchanging crypto at a loss will recognize the loss even if the same crypto is immediately repurchased. However, the capital loss will face normal capital loss limitations if there is not a capital gain to offset the loss.
Not all activity is taxable
Keep in mind that selling crypto for cash, trading one cryptocurrency for another cryptocurrency, using crypto at a merchant as payment, mining crypto, or getting paid in crypto are all taxable events. However, transferring the same cryptocurrency from one exchange or wallet to another is not taxable. Buying cryptocurrency, gifting crypto, or donating crypto also do not trigger taxable events.
Short-term vs. Long-term
Normal holding periods apply to cryptocurrency. If held for one year or less, any profits triggered from the sale or exchange of crypto are considered short-term capital gains. This is taxed at regular income tax rates. If held for more than one year, profits earned are considered long-term capital gains, which are taxed at 0%, 15%, or 20% currently based on annual income and the corresponding tax brackets.
If you earn cryptocurrency by mining it, or received it as payment for goods or services, it is considered regular taxable income. Tax is owed on the entire value of the crypto on the day you receive it. This can also be subject to self-employment tax if the mining activity is a trade or business. If you sell or exchange the crypto at a later date, the difference in value from the day you acquired to the day you sold would be subject to capital gain/loss rules. Crypto mining that is not a trade or business can potentially be reported as a hobby, which would not be subject to self-employment tax. However, as a hobby you can be more limited on what you can deduct as expenses. Mining expenses can include computers, servers, utilities, and other costs to generate the mining of crypto.
Investing in crypto through a traditional IRA or Roth IRA can defer or avoid the capital gains. This can be tricky because a lot of financial advisors are not licensed to sell crypto, but there are options such as self-directed IRAs or specific investment firms that offer crypto investing.
Crypto can be donated directly to charity. If donated, you get a potential tax deduction for the full value of the crypto at the time of the donation. If you held the crypto for more than one year and it has increased in value since you bought it, the donation would be based on the increased fair market value thus avoiding the capital gains tax and potentially deducting the full value as a charitable contribution.
This is just a summary and there could be additional taxes or limitations depending on each specific scenario. Please contact us for more information.