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Cryptocurrency Taxes: A Guide to Tax Rules for Bitcoin, Ethereum, etc.


With the meteoric rise in the value of certain cryptocurrencies such as Bitcoin and Ethereum, traders and crypto enthusiasts may have serious tax issues in mind. With the Internal Revenue Service (IRS) stepping up its law enforcement efforts, even those who hold the currency – let alone trade it – must ensure they aren’t breaking the law. It might be easier to do than you think, given the way the IRS treats cryptocurrency.

“It’s a very big area of ​​application for the IRS right now,” says Brian R. Harris, tax attorney at Fogarty Mueller Harris, PLLC in Tampa. “They generate a lot of publicity by preying on people who hold, trade or use cryptocurrencies. These people can be a target for an audit or a compliance check.

While one of Bitcoin’s selling points, for example, has been its anonymity (or at least semi-anonymity), authorities have caught up in recent years with some success.

“IRS and FBI are improving in tracking and tracing Bitcoin in criminal investigations,” says Harris. And they can freeze assets, if necessary, he adds.

This is one more reason for those who carry out cryptocurrency transactions to know the law and the taxes they could incur by their actions. The good news: The IRS treats cryptocurrencies the same way it treats other fixed assets like stocks and bonds. The bad news: This treatment also makes it difficult to actually use cryptocurrency to purchase goods and services.

Here are a number of key things you need to know about cryptocurrency taxes and how to stay on the right side of the law.

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7 things you need to know about cryptocurrency taxes

1. You will be asked if you own or use cryptocurrency

Your 2021 tax return requires you to report whether you have traded in cryptocurrency. In a clear place near the top, the Form 1040 asks, “At any time in 2021, have you received, sold, sent, traded, or otherwise acquired a financial interest in a virtual currency?” “

You are therefore forced to answer definitively if you have carried out cryptocurrency transactions, which puts you in a position to potentially lie to the IRS. If you don’t answer honestly, you could be in further legal danger, and the IRS doesn’t look kindly on liars and tax evaders.

However, there is a footnote. In a recent clarification, the IRS said taxpayers who only bought virtual currency with real currency were not required to answer “yes” to the question.

2. You don’t escape taxation just because you didn’t get 1099

With a bank or brokerage, you (and the IRS) will usually get a Form 1099 showing the income you received during the year. This may not be the case with cryptocurrency, however.

“There isn’t really the same level of reporting for cryptocurrency yet, compared to typical 1099 forms for stocks, interest, and other payments,” says Harris. “The IRS doesn’t get great reports from Coinbase and other exchanges.”

However, a November 2021 law will require greater tax reporting for industry players from January 1, 2023. The law requires brokers – controversially including anyone who moves digital assets for another – to report this information to the IRS on a 1099 or similar form.

Opponents claim the law would force anyone who moves cryptocurrency, including miners and crypto wallets, to the new rules, including those who do not have access to that information. However, lawmakers are already working on a new bill to define more precisely to whom the law applies.

But not having a 1099 will not allow you to escape any tax liability, and you will still have to report your earnings and pay taxes on them. Still, it’s not all bad news: if you were to incur a capital loss, you can deduct it on your return and reduce your taxable income.

3. Merely using crypto exposes you to a potential tax liability

You might think that if you only use – but don’t trade – cryptocurrency, you are not liable for taxes.

Not true!

Anytime you trade virtual currency for real currency, goods, or services, you may create a tax liability. You will create a liability if the price you make for your cryptocurrency – the value of good or real currency you receive – is more than your base cost in the cryptocurrency. So if you get more value than you put into the cryptocurrency, you owe taxes.

Of course, you might as well incur a tax loss if the value of the goods, services, or real currency is less than your base cost in cryptocurrency.

Either way, you’ll need to know your cost base to do the math.

It is important to note that this is not a transaction tax. It is a capital gains tax – a tax on the realized change in value of the cryptocurrency. And like the stocks you buy and hold, if you don’t trade the cryptocurrency for something else, you haven’t realized a gain or loss.

4. Gains on crypto trading are treated as regular capital gains

So you made a profit on a profitable transaction or purchase? The IRS generally treats cryptocurrency gains the same way it treats any type of capital gain.

That is, you will pay ordinary tax rates on short-term capital gains (up to 37% in 2021 and 2022, depending on your income) for assets held for less than one year. year. But for assets held for more than a year, you’ll pay long-term capital gains tax, likely at a lower rate (0, 15, and 20%).

And the same rules for clearing capital gains and losses also apply to cryptocurrencies. This allows you to deduct capital losses and realize a net loss of up to $ 3,000 each year. If your net losses exceed this amount, you will have to carry them forward to the following year.

5. Crypto miners may be treated differently from others

Are you mining cryptocurrency as a business? Then you may be able to deduct your expenses, as a typical business would. Your income is the value of what you produce.

“If you mine cryptocurrency, you earn income at fair market value, so that’s your base in cryptocurrency,” says Harris. “If it is a business or a business, your expenses may be deductible. “

But that last element is the key point: you must run a business or business to be eligible. You can’t run your mining rig as a hobby and enjoy the same deductions as a real business.

6. A crypto giveaway is treated the same as other giveaways.

If you have given someone, perhaps a younger relative, cryptocurrency to generate interest, your gift will be treated the same as any similar gift. It may therefore be subject to gift tax if it exceeds $ 15,000 in 2021 (or $ 16,000 in 2022). And if the time comes for the recipient to sell the gift, the base price remains the same as the donor’s base price.

That said, there are ways to avoid gift tax even if you exceed the annual threshold, such as taking advantage of the lifetime exemption.

7. Legacy cryptocurrency is treated like other legacy assets

Legacy cryptocurrency is treated like other fixed assets that are passed down from generation to generation. They may be subject to inheritance tax if the estate exceeds certain thresholds ($ 11.7 million and $ 12.06 million in 2021 and 2022, respectively).

Like stocks, cryptocurrency benefits from an increased cost basis at fair value on the day of death. So generally, cryptocurrency is treated for most people like a typical fixed asset, says Harris.

At the end of the line

It can be surprisingly onerous to actually use cryptocurrencies, tracking your cost base, scoring your actual realized price, and potentially tax owed (even without an official Form 1099 declaration). Additionally, the IRS is stepping up enforcement and oversight of potential tax evasion by taking a closer look at who trades cryptocurrency. All of these factors contribute to making cryptocurrencies more difficult to use and likely hamper their wider deployment.

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