When You Sell Or Dispose Of Cryptocurrency, That Transaction Can Be Subject To Capital Gains Tax.
Once you understand how crypto assets are taxed, you can better minimize your tax liabilities.
Capital Gains on Cryptocurrency
A capital gain is the profit you make from selling an asset. Capital gains taxes can apply to assets such as real estate, businesses, cars, stocks, bonds, mutual funds, and other investment vehicles.
Selling one of these assets can trigger a taxable event, and you are typically required to report any gains to the IRS.
The same rules apply to crypto. The IRS defines Bitcoin, Ethereum, Dogecoin, and other cryptocurrencies as assets for tax purposes.
If you buy 1 Eth for $1,500 and sell it for $1,700, your $200 profit is taxable income. (If you incur selling fees in the transaction, you’d subtract those fees before calculating profit.)
However, if you bought 1 Eth when the market was high at $4,500 and later sold it for $1,500, you’d have a “capital loss” of $3,000.
Those losses can be used to offset other tax liabilities. More on that below.
Before we did deeper into capital gains, it’s important to understand what types of cryptocurrency transactions can trigger capital gains taxes. They include:
- Selling crypto and converting it to cash
- Using crypto to purchase goods and services
- Earning crypto through mining or selling goods and services
- Trading one type of cryptocurrency for another
Overall, you must pay taxes to the IRS on your cryptocurrency investments any time you sell, trade or dispose of any crypto and it has increased in value since you bought it.
(Learn more in our cryptocurrency tax primer.)
Long-Term vs. Short-Term Capital Gains for Crypto
The IRS taxes capital assets differently depending on how long you owned them. If you owned your cryptocurrency for less than a year, your gains or losses will be classified as “short term.”
If you owned your crypto for more than a year, it will be taxed under “long-term” rates.
Short-term capital gains: When you hold an asset for less than a year, you will be taxed at the short-term rate. Short-term capital gains are taxed at the same rate as ordinary income, such as wages from a job.
Short term rates range from 10% to 37% in 2022, depending on your filing status and your income bracket. The IRS has seven tax brackets for ordinary income:
2022 Ordinary Income Tax Brackets
|Filing Status ||10% ||12% ||22% ||24% ||32% ||35% ||37% |
|Single ||Up to $10,275 ||$10,276 to $41,775 ||$41,776 to $89,075 ||$ $89,076 to $170,050 ||$170,051 to $215,950 ||$215,951 to $539,900 ||Over $539,900 |
|Married filing jointly ||Up to $20,550 ||$20,551 to $83,550 ||$83,551 to $178,150 ||$178,151 to $340,100 ||$340,101 to $431,900 ||$431,901 to $647,850 ||Over $647,850 |
|Married filing separately ||Up to $10,275 ||$10,276 to $41,775 ||$41,776 to $89,075 ||$89,076 to $170,050 ||$170,051 to $215,950 ||$215,951 to $323,925 ||Over $332,925 |
|Head of household ||Up to $14,650 ||$14,651 to $55,900 ||$55,901 to $89,050 ||$89,051 to $170,050 ||$170,051 to $215,950 ||$215,951 to $539,900 ||Over $539,900 |
Long-term capital gains: Long-term rates apply when you’ve held an asset for more than a year. The IRS has three brackets for long-term rates, from 0% to 20%.
2022 Long-Term Capital Gains Tax Rate
|Filing Status ||0% ||15% ||20% |
|Single ||Up to $41,675 ||$41,676 – $459,750 ||Over $459,750 |
|Married filing jointly ||Up to $83,350 ||$83,351 – $517,200 ||Over $517,200 |
|Married filing separately ||Up to $41,675 ||$41,676 – $258,600 ||Over $258,600 |
|Head of household ||Up to $55,800 ||$55,801 – $488,500 ||Over $488,500 |
Minimizing Crypto Taxes
As shown above, long-term capital gains rates are lower than short-term rates. So, if you want to minimize your tax bill, hold your cryptocurrency for at least one year.
For example, let’s say Frank is a single filer making $55,000 a year from his regular job. In 2022, Frank bought and sold a crypto share at a profit of $500. Frank falls into the 22% ordinary income tax bracket, so that $500 profit would be taxed at 22% or $110.
Now let’s imagine Frank bought that crypto share more than a year ago. If he sells it in 2022 and makes a $500 profit, the sale would be subject to 15% capital gains rate, or $75.
Offsetting Capital Gains with Capital Losses
As previously mentioned, if you realize a loss when you sell an investment, that loss can be used to reduce your taxes.
You can subtract crypto losses from the taxable gains of other assets that have appreciated in value, with some limits, as follows:
- If you have a net loss on your capital assets, you can apply up to $3,000 in loss per year to other taxable income.
- Additional losses above $3,000 can be carried forward and applied to future years.
- When calculating losses, you must start by offsetting losses of the same type. In other words, short-term losses first reduce your short-term gains while long-term losses first offset long-term gains.
Calculating Crypto Gains: FiFO, LIFO, HIFO
If you’re a crypto investor who has purchased multiple shares over time, you have separate lots for each purchase. When it comes time to sell, your profits (or losses) will depend on which lot you sell.
FIFO, LIFO, and HIFO are all acceptable accounting methods for determining how your gains are measured. Here is what these acronyms mean:
- FIFO (first in first out): Calculates your taxes as if the first unit you purchased is the first unit you sell.
- LIFO (last in first out): Calculates your taxes as if the last unit purchased is the first unit for sale.
- HIFO (highest in first out): Calculates your taxes using the crypto unit with the highest purchase price as the unit sold first.
It’s possible that different accounting methods can significantly reduce your tax bill. Which accounting approach works best can vary based on market conditions.
Tax Saving Strategies for Crypto Currency
Overall, you can use several strategies to minimize your tax bill – and understanding the difference between long-term and short-term capital gains is just one of them.
Popular strategies include:
- Holding cryptocurrency for more than a year: That allows you to take advantage of the lower long-term capital gains rate.
- Offsetting tax losses: Tax loss harvesting strategies involve selling an asset at a loss to reduce capital gains. Investors may then buy a similar investment back at a lower price, essentially replacing it in their portfolio for later gains.
- Optimizing your accounting method: Choosing FIFO, LIFO, or HIFO can help you save, depending on holding periods and market conditions.
- Investing in tax-advantaged accounts: You can avoid or defer capital gains taxes by investing your cryptocurrency in an IRA, 401(k), or other tax-advantaged investment vehicle.
Crypto taxes can be confusing, and it’s easy to get into trouble by not reporting it accurately or not paying the taxes you need to. If you didn’t report your crypto properly and the IRS has sent you a notice, speak with an experienced crypto tax attorney for help.