Cryptocurrency taxation in the US

Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

To begin, the most common factors affecting how cryptocurrencies are taxed in the US are as follows:
1. How long you've held the digital asset
2. Your income bracket
3. Whether you can employ tax-loss harvesting

Table of Contents

  1. Crypto capital gains
  2. Tax loss harvesting
  3. Identifying lots
  4. What if I use my crypto to buy something? Do I still have to pay taxes?
  5. Is there a tax exemption for small crypto purchases in the US?
  6. What if I'm paid in crypto? How will I be taxed?
  7. Does trading one cryptocurrency for another cryptocurrency count as a taxable event?
  8. How does US tax law treat cryptocurrency airdrops?
  9. How does US tax law treat cryptocurrency forks?
  10. How does US tax law treat cryptocurrency staking?
  11. Is there software to help with crypto tax reporting?

Crypto capital gains

First of all, you generally won't incur a 'taxable event' until you sell (or exchange your crypto for a good or service). We say generally because if you're earning interest on your crypto holdings, that interest is considered 'ordinary' taxable income.

Ok, let's look at a simple capital gains example. Imagine you bought 1 BTC for $10,000 on January 1st and sold it for $15,000 six months later on June 1st. In this scenario, your cost basis is $10,000 and your gain is $5,000. Your gain is the amount you'll be obliged to pay taxes on. Simple enough.

But how much tax do you have to pay? This will depend on:

  1. Your total capital gains for the entire the tax year (including gains made from non-crypto trading) - the more you made, the higher your tax rate.
  2. Your income bracket. Being in a higher income bracket subjects you to a higher tax rate on your capital gains. For more information about current tax brackets, see the Internal Revenue Service (IRS) website:
  3. How long you held the investment. If you held for less than a year, the gains are added to your 'ordinary' income which generally means you'll be subjected to a higher tax rate. If you held the asset for more than a year, profits are counted as 'capital gains,' which, in most cases, are taxed at a lower rate.

Tax loss harvesting

Tax-loss harvesting is when you sell investments at a loss in order to reduce your tax liability. Imagine you bought one bitcoin at $10,000 and sold it in the same year for $15,000. You'd have a $5,000 capital gain, which of course is a tax liability. Now let's say you had also purchased $10,000 worth of Tesla shares in the same year and that the price tanks. You strategically decide to sell your Tesla, incurring a loss of $5,000. You can use this loss to offset your bitcoin gains, thereby eliminating your tax liability. Next, you wait the legally-required 30 days from the moment you sold your Telsa shares before buying back in. Luckily the price hasn't recovered, so - in effect - you've completely avoided your tax liability on your Bitcoin gains while not diminishing your Tesla position.

Because the IRS classifies cryptoassets as property, it may mean that the 'wash sale' rule doesn't apply. This would eliminate the need to wait 30 days before buying back into crypto after recognizing a loss. However, because the IRS hasn't specifically stated whether the rule applies to crypto - indeed some cryptoassets are being treated as securities, not property - many traders are playing it safe by waiting 30 days before buying back in.

The good news is that, since you can harvest an unlimited amount of losses and carry them forward into an unlimited number of tax years, you should have plenty of opportunity to take advantage of this tax strategy.

Identifying lots

Say you buy one bitcoin at $10,000 and one more at $20,000. Later you sell one coin for $15,000. Did you incur a capital gain or a capital loss? The answer is, it's up to you.

Option 1: 'First-in, first-out.' Here, you'd have made a $5,000 capital gain.

Option 2: 'Specific identification.' Here, you decide which coins you're selling at the moment of each sale. With this method, you'll be required to keep meticulous records, but you have more flexibility to minimize your tax burden, including the potential to deploy a tax-loss harvesting strategy.

What if I use my crypto to buy something? Do I still have to pay taxes?

Converting cryptocurrency to goods or services is treated no differently than trading it on an exchange. This means that the above-described rules apply. Let's look at an example:

Image you bought 1 BTC for $10,000 on January 1st. By June 1st, the price of Bitcoin has doubled to $20,000. With your new-found wealth, you decide to buy a $20,000 car using your 1 BTC. What you may not realize is that the moment you send your BTC to the seller to pay for the car, you're incurring a $10,000 gain. This is a taxable event, meaning you'll need to factor it in to your tax report.

Is there a tax exemption for small crypto purchases in the US?

There is no exemption. Lawmakers have twice failed to pass legislation that would provide an exemption for small purchases. The more recent bill, called the Virtual Currency Tax Fairness Act of 2020, had proposed an exemption on sales valued at less than $200. Introduced at the start of 2020, the bill was pronounced dead in December 2020.

What if I'm paid in crypto? How will I be taxed?

In terms of price appreciation or depreciation, the same above-described rules apply. This means that if, for example, you receive cryptocurrency in exchange for goods or services on January 1st, the price of the cryptocurrency on that date is considered your cost basis. If sell the cryptocurrency or use it to buy something, your profit or loss will depend on the price at the time you exchange (minus fees).

Of course, getting paid in cryptocurrency also subjects you to income tax the same way getting paid in dollars does. This means that, for example, if you immediately sell your cryptocurrency into USD at the moment you receive it, your tax bill will be exactly the same as if you'd received dollars.

Does trading one cryptocurrency for another cryptocurrency count as a taxable event?

Yes. The so-called 'like-kind' rule does not apply when trading cryptocurrency as it does to the swapping of real estate. In other words, when you sell one cryptocurrency for another, it's considered a taxable event, meaning you'll need to determine your cost basis and report capital gains.

How does US tax law treat cryptocurrency airdrops?

If you've received a token in one of your wallets, whether you asked for it or not, you're technically required to report the value of that token as ordinary income. You calculate your cost basis at the moment the token was airdropped to you. For example, if you received 400 UNI tokens on Sept 17, 2020 at 11AM - when the price was $0.40/UNI - your cost basis would be $160. If you sold it two days later for $6/UNI you'd have a capital gain of $2240.

How does US tax law treat cryptocurrency forks?

Just like airdrops, forks are considered ordinary income. You cost basis is, again, calculated at the moment the fork occurred.

How does US tax law treat cryptocurrency staking?

Tokens earned from staking are treated, like interest on bank deposits, as ordinary income.

Is there software to help with crypto tax reporting?

Since cryptocurrencies are both an investment vehicle and a medium of exchange, reporting your taxes correctly can be an extremely time consuming task. Further, tax laws are rapidly evolving. Luckily there's a growing variety of tools that help you comply. We recommend TokenTax, which is a crypto tax software platform and crypto tax calculator that vastly simplifies the process. It helps you connect to exchanges, track your trades, generate the needed forms, and automatically compile your tax report. Particularly if you intend to deploy strategies like tax-loss harvesting, you'll want to use capable software to ensure you minimize your tax burden.

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