Full Process Of Cryptocurrency Taxes
Creating headlines on several news articles almost every day currently, cryptocurrency has managed to serve as an interesting subject portrayed through social media posts. It has gone on to gain momentous traction and set a name that would go a long way in mainstream culture.
The first digital currency, Bitcoin has shown exponential growth in the past few years. It started with a total market capitalization of a modest $10 billion in July 2016 and went on to achieve more than $1.1 trillion in early 2021. However, although it is not the most exciting aspect of investing in crypto, it is necessary to know about the taxes on crypto if you were to invest. While cryptocurrencies are still new, finance divisions of countries worldwide are toiling to impose crypto tax compliance.
There have emerged lots of ways that tax you for owing crypto, and even trading one of them for another is an event that is taxed. If you fail to keep accurate records of your transactions, it will prove to be difficult to keep track of your gains and losses during taxation. Moreover, if you fail to pay your crypto taxes, it would incur steep penalties even when it is an honest mistake.
What is the tax rate for cryptocurrencies?
The tax rate for cryptocurrencies in the case of federal taxes is similar to that of the capital gains tax rate. It hovers around 10-37% in the case of short-term capital gains whereas it lingers around 0-20% in the case of long-term capital gains. In most countries now, crypto-asset gains are determined based on two factors: your income and the period you held the cryptocurrency (holding period).
Your holding period is counted from the day when you purchase the crypto asset or forth the cryptocurrency transaction and goes on until the day that you sell/trade/send that particular capital asset. This is where the terms of long-term capital gains and short-term capital gains come in handy.
Long-term capital gains and their tax rate
If your cryptocurrency coins consist of a holding period of more than 366 days, they will be treated as tax liabilities between 0-20% and their taxation would be determined based on your ordinary income tax rate.
Short-term capital gains and their tax rate
If your cryptocurrency coins consist of a holding period of 365 days or less, they will be treated as ordinary income and will be subjected to short-term capital gains taxation.
Whenever you conduct a taxable event involving your cryptocurrency investments, you are required with an obligation to report it with your taxes. Any event in which you gain or extract profits qualifies as a taxable event.
About crypto, these events that qualify as taxable can be categorized into two separate categories: income tax events and capital gains tax events. It’s important to be aware of what events qualify as which category as they are taxed differently.
Tax Events involving Capital Gain
Below listed are the tax events that involve short-term capital gain and long-term capital cryptocurrency gain regarding which the cryptocurrency tax rates are enforced as of 2021:
Selling cryptocurrency in return for fiat currency (such as the US dollar, the euro, and the pound sterling)
For an instance, if you manage to buy 2 Ethereum (ETH) amounting to $500 each and then sell them at $350 each a few months later, the capital loss of $300 will be deducted, reducing your taxable income.
Using cryptocurrencies to purchase goods/services
For an instance, you had bought five bitcoins through a bitcoin transaction at $150 each before 2014. Thanks to the newfound price of bitcoin now, one bitcoin lets you purchase a brand-new Harley-Davidson motorcycle at $56,000, assuming that at the time of buying the bike, one bitcoin’s worth is $56,000.
In the aforementioned example, a taxable event is incurred when you use your bitcoin to buy the Harley-Davidson (thereby making a bitcoin transaction). Thus, your capital gain of $56,000 incurred is required to be accounted for in your taxation.
Trading or exchanging different crypto assets
This can be established either through an exchange or directly via peer-to-peer. An example follows: you bought ten Litecoin at $50 each. A few months pass and you trade all ten Litecoin for one Ethereum (ETH). However, when you make the trade, ten Litecoin are now worth $300 each.
Hence, the capital gain amounting to $2,500 incurred when you trade your Litecoin for Ethereum requires to be reported into your tax report as well.
It is worth mentioning that if you simply perform a transfer of assets from one exchange or wallet to another, it is not considered to be a taxable event since it does not involve triggering any capital gains or losses.
Are cryptocurrencies taxed just as stocks?
Though a brief answer to this would be yes, there is more to it. The cryptocurrency tax rate determined is based on all cryptos considered similar to stocks or bonds (or capital assets), instead of a fiat currency (such as dollars or euros).
It is required for you to pay your taxes whenever you make a profit from selling your capital assets. Hence, when you purchase products or services and pay with digital currency transactions, and if the amount of crypto spent by you has spiked in value compared to what you had paid for it when you bought it, it triggers capital gains taxes.
Similar to stocks, you only owe capital taxes for crypto if you sell it or spend it and make a profit off the transaction. If you happen to incur a loss, although you do not owe any taxes for such a transaction, you must still report these crypto losses whilst filing your tax report.
For an instance, if you bought Ethereum worth $5,000 and sold it for $9,000, your taxable capital gain would amount to $4,000. However, if you end up selling it for $4,000 instead, you would not owe anything in taxes as a result of you incurring a loss of $1,000.
Capital losses arising from your cryptocurrency transactions can benefit you when it comes to tax savings. Equipped with a stratagem known as tax-loss harvesting, you can sell your cryptocurrency assets when you are in a position to incur a loss to offset any potential capital gains.
How to determine what you owe Taxes
Determining how much profit you have extracted and how much you are liable to pay as taxes is more than just complicated.
Exchanging cryptocurrencies
Investors are exposed to taxes as well when it comes to exchanging cryptocurrencies. You would technically and effectively sell Bitcoin if you were to use it to buy Ethereum, so you will be required to report the difference in prices of the Bitcoin between when you purchased it and when you spent it to buy Ethereum. You would also need to make note of the price of Ethereum when you purchase it for when you sell it later.
A lot many exchanges enable crypto traders to keep track and organize all this information by offering cost-free exports of all trading data, which can be determined to calculate tax burden by an accountant (or a diligent enthusiast). Blockchain solutions too are well-suited to track this data and highlight appropriate points that pose tax interest.
Cashing Out of Crypto
By standard tax rules, if you intend to cash out cryptocurrency for fiat money such as dollars, you will need to know the basic price of the Bitcoin they are selling. Selling the cryptocurrencies that are mined instead of those which were bought previously with fiat is a different story altogether. Since they are paid in dollars for mining inputs that can only be defined as work (the term “Proof of Work” indeed makes it so), the profit gained from selling mined cryptocurrencies is taxed and treated as business income. One can also deduct the expenses that are spent because of their mining operation, such as electricity and PC hardware.
Personal Purchases
The taxes charged for buying a cup of coffee with cryptocurrency are mostly convoluted. One must be aware of the basic price of the Bitcoin they are using to buy the coffee, then reduce the cost of the coffee from it. If the buyer chooses to trade coins frequently, it becomes increasingly complicated to determine which coins were used to make the personal purchase, their basic price, and exact gains, with every purchase. Hence, it becomes crucial to remember and keep track of all transaction information for every digital wallet and currency you own.
A Final Word
It is always strongly advised to refer to a proficient accountant whilst attempting to file cryptocurrency taxes for the first time. Although it might seem daunting to effectively manage a multi-year trading career, it requires to be done, and it is getting easier as CPAs and other tax professionals are associating themselves more with crypto assets.
