do you have cryptocurrencies? Maybe you bought bitcoin years ago when it was priced at $100 and decided to make a big profit this year. or maybe you joined the revolution late and bought some ethereum, only to turn around and sell it for easy money. either way, your crypto transaction may affect your 2021 tax bill.
how do cryptocurrency taxes work?
For better or worse, capital gains tax rules apply to cryptocurrencies like bitcoin and ethereum. The Internal Revenue Service (IRS) treats all cryptocurrencies as capital assets, and you owe taxes when they are sold at a profit. this is exactly what happens when you sell more traditional investments, like stocks or funds, at a profit.
Reading: Taxes on bitcoin mining
The amount you own in capital gains taxes depends on whether you have held your crypto for less than a year or more than a year. If you haven’t made it to 12 months, your earnings are taxed at short-term capital gains rates, also known as your regular income tax rate. But if it’s been at least a year since you bought your coins, you’ll qualify for a long-term capital gains rate that’s lower than most income taxes, depending on your taxable income.
And just like if you sell any other investment at a loss, if your cryptocurrency investment has lost value when you sell it, you can claim a capital loss, which you can use to offset other income taxes.
but cryptocurrency taxes come with a couple of extra details.
crypto taxes if you use crypto for purchases
If you buy goods or services with cryptocurrency, your purchase counts as a sale of that cryptocurrency. This means that you will owe capital gains tax if your coins have increased in value above what you originally paid for them. and what’s more, you’ll also owe any applicable sales tax.
crypto taxes when you mine crypto
If you earn cryptocurrency by mining it, or receive it as a promotion or as payment for goods or services, it counts as part of your regular taxable income. you owe tax on the full fair market value of the cryptocurrency on the day you received it, at your regular income tax rate.
and if you have the same cryptocurrency that you mined or earned from these activities, its value increases and you spend or sell it later for a profit, you will also owe capital gains tax on the profits, depending on how long I have sustained it.
how to file your crypto taxes
It’s never too early to get organized with your crypto taxes. the standard form 1040 tax return now asks if you engaged in any virtual currency transactions during the year. If the answer is yes, here’s what to keep in mind:
1. keep records of all transactions
You must keep track of all your cryptocurrency transactions, including how much you paid for them, how long you held them, and how much you sold them for, as well as receipts for each transaction.
While your crypto exchange may provide a 1099-b form reporting your crypto transactions to both you and the IRS, it may not record the cost basis or original amount you paid for your crypto if you transfer coins between offline cold wallets and your account.
To help address issues like these, “software companies have emerged that will cleanse the blockchain to detect transfers between your wallets, whether on an exchange or not, and provide you with reports of all wallet-related transactions to deliver to you within a certain fiscal year,” says Jon Feldhammer, tax partner at Baker Botts.
tools like koinly and cointracker connect to crypto exchanges and wallets to track your crypto transactions and fill out the forms you need to file your crypto taxes.
2. complete the appropriate tax forms
once you have a record of your crypto transactions, you will need to fill out certain tax forms depending on how you have used your crypto:
- Form 8949. This form records each purchase or sale of cryptocurrency as an investment. this should include the total number of coins, the date and price you bought, the date and price you sold, and your profit or loss for each transaction.
- schedule d. this form summarizes your total capital gains and losses from all investments, including crypto.
- attachment c. if you received coins from mining, you must report if you received them as a business or as a hobby. If you have a crypto mining business, you may owe self-employment tax if your income exceeded your expenses for the year.
- Schedule 1. If you report your crypto mining as a hobby , you must report this income on line 8 of schedule 1. You will not owe self-employment taxes, but you will be more limited in what you can deduct as an expense.
3. file your taxes
If you keep records in software like koinly or cointracker, you can connect them to the online tax software of your choice. then use online tax software to file your general state and federal tax returns. For those looking for one-stop-shop services, TokenTax offers a full suite of accounting services to track and prepare both your crypto and regular taxes.
4. hire a professional
Preparing for taxes on cryptocurrencies can be tricky, especially as the laws surrounding cryptocurrencies are constantly evolving. If you’ve made substantial income from cryptocurrencies, it may be worth hiring a certified public accountant (CPA) who specializes in this type of tax work, so they don’t have to come after you later.
how to minimize crypto taxes
If you think you might owe cryptocurrency taxes in the future, here are six ways to help minimize them:
1. hold cryptocurrencies long-term
If you hold a cryptocurrency investment for at least a year before selling it, your earnings qualify for the long-term capital gains prime rate. Depending on your taxable income for the year, this can cut your tax rate almost in half, from a top rate of 37% for short-term gains to a top rate of just 20% for long-term gains.
2. offset gains against losses
As with any investment, you can take advantage of crypto gains by claiming losses on other investments in the year you make your gain. That means if you made $10,000 from selling bitcoin but lost $10,000 from selling ethereum, you won’t owe any tax since you broke even.
However, these losses are not limited to other forms of cryptocurrency. If you’re about to cash in on a big crypto investment, check out the rest of your portfolio to see if there are other losing investments you could sell to offset your gains. And if you end up losing substantially more than you earn in a year, you can deduct up to $3,000 in excess losses against your personal income taxes, as well as carry forward any unused losses to offset your future investment earnings.
3. time of sale with your tax rate
If you have the luxury of time on your side, you can always try waiting for a lower tax rate to come along, says Jeff Hoopes, an associate professor at the University of North Carolina and director of research at the UNC Tax Center. .
“Maybe you got laid off, retired, went back to school, or moved to a state with lower taxes. so he may be in a lower tax bracket, which would allow him to sell his crypto while he owes less tax,” he says.
4. claim mining expenses
While it may seem like a low-cost activity in theory, cryptocurrency mining involves considerable expenses, including costs for computers, servers, electricity, and internet service provider. If you’re a crypto miner, you can deduct these costs from your mining income, although the amount you can deduct depends on whether you classify your operation as a business or a hobby.
5. consider investing through a retirement plan
If you invest in cryptocurrencies using a retirement plan like a traditional IRA or a Roth IRA, you can defer or completely avoid investment earnings, although it’s not as easy as investing through a regular brokerage account.
“There are ways to incorporate cryptocurrency into tax-advantaged vehicles like an individual retirement account (IRA), but it’s not as common or as easy (although many hope it will be easier),” says Hoopes. Right now, if you want to open a crypto or bitcoin IRA account, you need to open a special account called a self-directed IRA account with boutique firms that offer cryptocurrency investment.
6. donate to charity
If you don’t need all of your crypto investment earnings, you can reduce your tax burden by donating at least a portion of your crypto to charity. you will get a deduction for the full value of your crypto, including any winnings. but this generally only makes sense if you’ve already planned to donate to a charity.