Cryptocurrency Taxes: What you Need to Know Before Paying

Cryptocurrency Taxes: What you Need to Know Before Paying

Do you have cryptocurrencies? Maybe you bought BTC when it cost $1 and decided to sell it this year and make a big profit from it. Or maybe you joined the latest revolution and bought Ethereum just to grab it and sell it quickly. Either way, your crypto transaction could affect your 2021 tax bill.

How do cryptocurrencies work?

Believe it or not, capital gains tax regulations apply to cryptocurrencies such as Bitcoin, Ethereum, and other altcoins. The IRS (Internal Revenue Service) treats all cryptocurrencies as capital goods, and you are required to pay taxes when sold for profit. This is what happens when you sell more conventional investments, such as stocks or funds, at a profit.

The amount you have in capital gains tax depends on whether you have held the cryptocurrency for less than a year or more than a year. If you have held it for less than 12 months, your income is taxed at the short-term capital gains rate, also known as the regular tax rate. But if a year has passed since you bought your coins, you'll be eligible for long-term capital gains that are lower than most income taxes, based on your taxable income.

And just like when you sell any other investment at a loss, if your cryptocurrency investment loses value when you sell it, you can claim a capital loss, which can be used to offset other income taxes.

However, cryptocurrencies present additional problems.

Cryptocurrency taxes if you use cryptocurrencies for purchases

If you buy goods or pay for services with cryptocurrency, your purchase is considered a sale of that cryptocurrency. This implies that you owe capital gains tax if the value of your coins has exceeded the value originally paid. In addition, you must pay any applicable sales tax.

Cryptocurrency taxes when mining cryptocurrencies

If you earn cryptocurrencies by mining them or earning them as an airdrop or payment for goods or services, it counts towards your normal taxable income. You owe taxes on the full fair market value of the cryptocurrency on the day you received it at the normal income tax rate.

And if you have the same cryptocurrency that you mine or earn from those assets, its value increases, and you then spend or sell it at a profit; you also owe capital gains tax, depending on how long you had it.  

How to file your crypto taxes

It's never too early or too late to get organized with cryptocurrency taxes. The standard 1040 tax return Form now asks if you traded in virtual currency during the year. If so, here's what to keep in mind:

1. Keep track of all transactions

You should keep track of all your cryptocurrency transactions, including how much you paid for the cryptocurrency, how long you held it, how much you sold, and how many receipts for each transaction.

Although your cryptocurrency exchange may provide a 1099-B that reports your crypto transactions to the IRS and you, it may not record the original cost basis or the amount you paid for the cryptocurrency if you transfer coins between cold wallets from your offline account to the exchange.

2. Complete the appropriate tax forms

Once you have a good record of your crypto transactions, you will need to complete some tax forms, depending on how you used the crypto:

  • Form 8949: This form records each purchase or sale of cryptocurrencies as an investment. It should include the total number of coins, the date and price you bought, the date and price you sold, and the profit or loss for each trade.

  • Schedule 1: If you report mining cryptocurrency as a hobby, you must report that income in line 8 of Schedule 1. You do not owe taxes for self-employment, but you will be more limited in what you can deduct as an expense.

  • Schedule C: If you received coins from mining, you must indicate whether you received them for work or as a hobby. If you are a cryptocurrency business, you may be required to pay self-employment taxes if your income exceeds your expenses for the year.

  • Schedule D: This form summarizes all investments' total gains and losses, including crypto-currencies.

3. File your taxes

If you keep records in some online software, you can connect them to the online tax software of your choice. Then use the online software to file general state and federal tax returns. 

4. Hire a professional

Preparing for cryptocurrency taxes can be difficult, especially as the laws on cryptocurrencies are constantly changing. Suppose you have earned a substantial income from cryptocurrency. In that case, it may be worth hiring a Certified Public Accountant (CPA) who specializes in this type of tax activity so that the IRS does not come after you.

How to Minimize Cryptocurrency Taxes

If you think you'll need to pay taxes in the future, here are six ways to minimize them:

Hold long-term cryptocurrencies

If you hold an investment in cryptocurrency for at least one year before selling it, your earnings will qualify for the preferential rate of long-term capital gain. Depending on your income that is taxable for the year, it can reduce your tax rate by almost half, from a maximum rate of 37% for short-term earnings to a maximum rate of only 20% for long-term earnings.

Offset profits with losses

As with any investment you make, you can take advantage of the profits of the cryptocurrency by claiming losses for other investments in the year in which you made a profit. This means that if you have earned $20,000 from the sale of Bitcoin but have lost $20,000 from the sale of Ethereum, you should not pay taxes because you broke even.

However, these losses are not limited to other forms of cryptocurrency. If you are about to make a large investment in cryptocurrency, check the rest of your portfolio to see if there are any other lost investments that you could sell to offset your gains. And if you lose substantially more than you earn in one year, you can deduct up to $3,000 more from your income tax losses and transfer any unused losses to offset future investment gains.

Time sales with a tax rate

If you have enough time, you can always try to expect a lower tax rate. Perhaps you were fired, retired, returned to school, or moved to a lower-paying state. Therefore, you may be in a lower tax category, which would allow you to sell your cryptocurrency for less tax.

Claiming Expenses for Mining 

While it may seem like a low-cost business, cryptocurrency mining involves considerable costs, including costs for computers, servers, electricity, and ISPs. If you are a cryptocurrency miner, you can deduct these costs from your mining income, although the amount to be deducted depends on whether you classify your operation as a business or a hobby.

Consider investing in a pension plan.

Invest in cryptocurrencies using a retirement plan, such as a traditional IRA or a Roth IRA. You may be able to defer or avoid investment gains altogether, although it's not as easy as investing in a regular broker's account.

There are ways to incorporate cryptocurrencies into tax-advantageous vehicles, such as an IRA, but it's not that common or easy (though many expect it to be easier). 

Donate to Charity

If you do not need all of your cryptocurrency investment income, you can reduce your tax burden by donating some of your cryptocurrency to charities. You will receive a deduction from the total value of the cryptocurrency, including any gains. But this usually only makes sense if you've already planned to donate to organizations.



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