Cryptocurrencies like Bitcoin, Ethereum, and Litecoin have gained significant popularity in recent years, with many people buying and selling them as investments. However, with this increased interest comes the question of how cryptocurrencies are taxed. Here is a more in-depth look at the current state of cryptocurrency taxation and some strategies for tax planning, with reference to Blake Hibbitts, CPA from Tax Planning Solutions LLC.
In the United States, the Internal Revenue Service (IRS) has issued guidance on how it views cryptocurrencies for tax purposes. According to the IRS, cryptocurrencies are considered to be property, rather than currency. This means that they are subject to capital gains tax, just like stocks or real estate.
If you buy a cryptocurrency and hold it for more than a year before selling it, any profit you make is considered a long-term capital gain and is taxed at a lower rate than short-term gains. The current long-term capital gains tax rates are 0%, 15%, or 20%, depending on your tax bracket. In contrast, short-term capital gains (holdings held for a year or less) are taxed at your ordinary income tax rate, which can be as high as 37%.
It's important to note that every time you buy or sell a cryptocurrency, you have a taxable event. This means that if you buy Bitcoin and then sell a portion of it for a profit, you will owe capital gains tax on that profit. Similarly, if you buy Bitcoin and it goes down in value, you may be able to claim a capital loss on your tax return. Capital losses can be used to offset capital gains you have realized elsewhere, which can help reduce your overall tax bill.
In addition to capital gains tax, you may also owe self-employment tax if you are mining cryptocurrencies. The IRS views mining as a trade or business, and any income you earn from it is subject to self-employment tax. This includes the fair market value of any cryptocurrency you mine, as well as any expenses you incur in the process of mining.
It's important to keep good records of all your cryptocurrency transactions. The IRS has specifically stated that it will be looking for people who are not reporting their cryptocurrency profits and may impose penalties for failure to report. You should keep records of all your buy and sell transactions, as well as any other cryptocurrency-related activity, such as mining or receiving cryptocurrency as payment. This includes keeping track of the cost basis (i.e., the original price you paid for the cryptocurrency) and the fair market value of the coins.
