Trading cryptocurrency is all the rage. It is rare to have a conversation with a colleague that does not include the ups and downs of crypto. If you have been dabbling in cryptocurrency or digital assets, are you aware of how crypto trading may affect your taxes? This exciting new hobby has earned a spot on your tax return, and you have specific reporting obligations to the IRS.
Let’s look at how crypto trading may affect your taxes and make sure you are not caught unaware this tax season.
What Exactly is “Crypto”?
When you hear the word “crypto”, you probably think of digital currencies like Bitcoin. But when we are talking about affecting your taxes, trading any kind of digital asset may result in tax owed.
A digital asset is anything created and maintained online in digital form that has value. Cryptocurrencies, which are digital currencies stored and traded online, are a form of digital asset.
Other types of digital assets besides cryptocurrencies include:
- Photos, videos, and books
- Documents, manuscripts, and audio files
- Email, chats, and metadata
- Accounts on websites like social media and gaming platforms
- Nonfungible tokens (NFTs)
- Security tokens
- Asset-backed coins or tokens, like stablecoins
Buying crypto IS NOT taxable.
The IRS recognizes cryptocurrency and digital assets as property. Just like buying most types of property, buying digital assets is not a taxable event. If you buy and hold onto your digital assets, you will not be taxed – even if it increases in value.
Selling or spending crypto IS taxable.
If you have a cryptocurrency or digital asset and you sell it or spend it, you have created a taxable event. You will need to determine if there was a gain or loss when you disposed of the digital asset, just like you would when selling a stock. Each of these capital transactions will need to be reported on your tax return, so keep extensive records.
Trading crypto IS taxable.
The high volatility in cryptocurrency and some digital assets is enticing for many. But let’s dive into how crypto trading may affect your taxes. If you buy one type of crypto and then at any point sell it to quickly (under one year) purchase another type of crypto, it is your responsibility to determine whether or not the crypto you traded increased in value from the time you purchased it to the time you traded it.
For example, if you bought $500 of Bitcoin (BTC) and it was worth $700 at the time you traded it for Ethereum (ETH), you have created a $200 gain that will need to be reported on your tax return.
Track your crypto losses.
If you were impacted by the declining cryptocurrency prices in 2022, you can write those losses off on your tax return. Each time you trade a cryptocurrency or digital asset at a value less than first purchased, notate that loss so you can report it on your tax return. These losses may help reduce your tax liability for the year. Just remember the maximum loss you can write off per year is $3,000.
What is the tax rate on cryptocurrency?
In order to determine your tax rate on the cryptocurrency and digital assets you traded throughout the year, you will need to look at two determining factors:
Length of time you owned the asset before selling it.
If you owned a certain type of digital asset for one year or less before trading it, you will pay short-term gains taxes on any gains. However, if you owned the asset for over 365 days, you will pay long-term gains taxes on existing gains.
Your annual income.
Short-term gains tax can range from 10-37%, while long-term gains range from 0-20%. The higher your income, the higher your tax bracket will be.
Trading crypto makes your taxes complicated.
Whether trading crypto or digital assets as a long-term investment or as a hobby, remember each trade causes a taxable event. Keep track of every trade throughout the year, showing all gains and losses, so you can report them on your tax return.
If you begin feeling overwhelmed with the complexity of tracking crypto trades, you may want to look into trading cryptocurrency stocks versus specific coins. If you begin to notice a large amount of gains from your trading, reach out to your accountant for a more detailed breakdown of how trading crypto may affect your taxes.
If you receive a 1099-K, give it to your accountant.
If you have traded more than $20,000 and/or have 200 crypto or digital asset transactions in one year, expect to receive a Form 1099-K. This alerts the IRS that you have had a lot of trading activity throughout the year. Whether you receive a 1099-K or not, all crypto and digital asset trading activity for the year needs to be reported on your tax return.
Failure to report trading cryptocurrency can hurt your wallet.
While many investors are interested in cryptocurrency and digital assets for their lack of regulation, the IRS still recognizes this industry and is constantly gathering information. Not reporting gains on trading digital assets can result in penalties and fines, in addition to back taxes. It could also increase your chances of being audited.
While trading cryptocurrency and digital assets may be a fun and exciting roller coaster ride, keep in mind the more you trade, the bigger your tax reporting responsibility. Keep a spreadsheet of all trades – including buy dates, sell dates, gains, and losses.
Give your accountant a head’s up on the complexities of your upcoming tax return reporting and ask them to assist you in tax planning. They are your lifeline to how crypto trading may affect your taxes, helping you prepare for any future tax liabilities that may be heading your way.