Your cryptocurrency trading might be costing you more than you realize in the form of taxes due to the IRS — and it’s critical to know what actions mean you have to pay and how much.
Many people who jumped into crypto investing recently are surprised when they find out they might have to pay taxes on it.
Essentially, like other investments such as stocks and mutual funds, the IRS defines Bitcoin, Ethereum and other cryptocurrencies as property for tax purposes.
The crypto market has had dramatic ups and downs lately, so new investors that have been buying and selling have to pay careful attention to ensure accurate reporting on their federal tax return.
The IRS is cracking down on cryptocurrency investors that fail to report their taxable transactions involving their digital assets. That likely means more IRS audit letters involving questions about cryptocurrency will land in taxpayers’ mailboxes in the coming months.
As of right now, reporting crypto transactions to the IRS isn’t necessarily easy to do because exchanges and brokerages are not yet required to send a typical Form 1099-B stating any proceeds, as you would for traditional investments.
That is supposed to change soon. Under a law signed in November 2021, crypto firms are slated to begin maintaining records of their investors’ transactions in 2023 and sending reports to both the IRS and the investors beginning in 2024. But there are reports that this deadline might be extended, which means that confusion around what to report and when is likely to continue, at least for a while.
In areas of confusion about taxes, like crypto, it’s easy to get into trouble with not knowing what to report to the IRS on your tax return, or not paying when you need to. An experienced tax attorney can guide you on what to do and help you understand what any letter you receive from the IRS requires.
When You Do Not Have to Pay Taxes on Crypto
For starters, there is a significant category of crypto investors who do not have to pay taxes on their crypto investments.
Simply purchasing some Bitcoin or another cryptocurrency and holding it in the exchange where you bought it or transferring it to your own cryptocurrency wallet is not a taxable event.
When You Owe Taxes on Crypto Investments & How The Amount Is Determined
Things get a bit hairier when you are trading in cryptocurrency. That is when taxes come into play.
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.
The times when you must pay taxes on your crypto investment transactions include (but are not limited to):
- Any time you convert crypto to cash dollars and make money on it, such as by selling it;
- When you use crypto to purchase goods and services;
- When you earn crypto through mining or selling goods and services; and
- When you trade one type of cryptocurrency for another.
In the eyes of the IRS, your crypto is property. That means that it is treated like other investments or assets. As a result, your crypto will be taxed based on how much you gained or lost in a period of time. These are known as capital gains and losses.
For example, let’s say you buy $1000 worth of crypto, make $1,000 on it, and then decide to sell it for $2,000. You must pay taxes on the $1,000 gain.
On the other hand, if you purchase $1000 worth of crypto, the value goes down to $500, and then you sell it, you can deduct the loss on your taxes. Your losses are determined on your investments overall, not based on one single investment or based on crypto alone. Generally, if your capital losses are greater than your capital gains, you can deduct up to $3,000 from your taxable income (for an individual tax filer).
Your tax amount will also be different depending on how long you owned the crypto before you sold it.
Reporting Cryptocurrency Investments on Your Federal Tax Return
How complicated your reporting requirements are will depend on how much crypto trading you are doing.
For crypto investors who bought a little virtual currency and are letting it sit, you don’t have to report it. It hasn’t gained or lost any taxable value until you do something with it, such as sell it or trade it.
For any crypto investor that has engaged in one or more taxable events with their crypto portfolio, that is when IRS reporting requirements are triggered.
As of right now, a crypto investor is completely responsible for keeping track of the value of their crypto investments, what they were worth when you bought them and what they were worth when you sold, traded, or disposed of your crypto.
Reporting could be relatively straightforward if you made a few trades and much more complicated if you’re investing more money in several different currencies with lots of trading.
For 2021, IRS Form 1040 includes a question immediately below the address block that says: “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”
Many taxpayers have wondered whether they must say yes simply because they bought some crypto and never sold it or paid for anything with it. It is important to know that the answer in that case is actually, “No.”
Then, you must use Form 8949 to reconcile any capital and gains and losses, including crypto, and report them on your Form 1040 using Schedule D.
The tax calculations and reporting around cryptocurrency can be more complicated in some cases. The IRS has started sending audit letters to people who are suspected to have made errors in crypto reporting or haven’t reported their virtual currency transactions.
If you have received an audit letter from the IRS and need help, speak to a tax attorney now.