When dealing with any asset, Uncle Sam wants its money. You cannot avoid taxes, you can but then you would be in trouble for tax evasion. Tax evasion is knowingly or unknowingly avoiding your dues, in other words, being ignorant to paying taxes is not an excuse for not paying on gains or losses. Penalties for tax evasion, according to the IRS, “include jail time of no more than five years, a fine of no more than $250,000 for individuals or $500,000 for corporations, or both—along with the costs of prosecution” (1). So, it would be wise to learn how taxes work with digital assets and how one can benefit from certain tax breaks, which lower your required taxes to pay.
What Are Taxable Events and Non-taxable Events?
Okay, now that all the doom and gloom stuff is out the way. I’m sure you are wondering why the heck am I going to be taxed for digital assets when cryptocurrency is supposed to be decentralized? Well, unfortunately anytime you gain or lose profit on digital asset you must file your taxes. One must know the difference between a taxable event and non-taxable. A taxable event simply means you will be taxed capital gains or losses based on what you do with your assets. Taxable events in cryptocurrency are mining, selling crypto for fiat (cash), switching one digital asset for another, buying goods or services with your digital assets. Non-taxable events are when you buy and hold your digital assets or when you transfer your digital assets from one wallet to another.
How Do I Calculate How Much to Report and What Are Capital Gains/Losses?
Without getting too far in the weeds on this. Utilizing Scenarios may be the best way to describe this. Let’s say for example you buy bitcoin for $5,000 on a crypto exchange and the value of bitcoin increases $10,000. So, you would have gained $5,000, if you decided to sale for cash, you would be taxed $5,000 for capital gains. Capital gains is when you make money on a digital asset, like the example. Capital loss is when you buy a digital asset at a higher cost, and it lost value or depreciated. For example, you bought bitcoin for $5,000 and loose $10,000 you would be taxed $5,000 if you sold the digital asset. Therefore, if you trade, bought, or sold your digital asset you would need to report the capital gain or loss. If you stake, mine, get paid crypto or earn interest on the digital asset you are taxed like ordinary income.
Short-term vs Long-term Capital Tax Gains/ Losses
As stated above capital gains or losses need to be reported. The way to report depends on your income or tax bracket you are in and how long you hold the digital asset. Long-term means you hold the digital asset for more than a year or 12 months. Short-term means you hold the digital asset for less than a year or 12 months. For example, in short-term if you buy ETH for $500 and sell it in 6 months for $1,000 you pay $500 in short-term gains. Now holding a digital asset long-term gives the investor benefits, such as, lower taxes. For example, at the highest you could be tax 20% on your capital gains/losses long-term, instead of 37% at the highest for short-term (2) for taxable events.
How Can I Benefit and Pay Less Taxes?
I’m sure by this point you have been wondering how you can save on your taxes regarding your digital assets. The most straightforward and easiest is buying and holding your asset, meaning don’t sell, switch or trade. Holding your assets are a way to create generational wealth, hold your digital assets in a wallet to save the value and not lose it on crypto exchanges, which are volatile. Gifting your digital assets will help you save on your taxes and/or donating. Tax-harvest loss is another way to save. Tax-harvest loss allows you to pay the difference between how much money lost compared to the capital gains you made that year.
Services that Calculate all my tax information
The problem with filing taxes for these digital assets is that it can become difficult to keep it all organized. Luckily, there are services that do this for you. One I personally use is Coin Tracker. Coin Tracker tracks all your transactions in your wallet and exchanges both centralized and decentralized. It also calculates the tax-harvest loss. There is a fee to have all your coins tracked, but I believe it is worth it and can save you a lot of headaches when filing your taxes. Just a reminder taxes are due April 18th for filing.
Cryptocurrency is a new form of asset and Uncle Sam wants its money. Especially, since many do not understand all the caveats of how this asset can or will be taxed. With new people become extremely wealthy, you can rest assure everyone wants their share. Hopefully this will help you along your journey on trying to keep your tax cost low when acquiring new digital assets and wealth. I am not a financial advisor, make sure to have a CPA or Tax attorney when dealing with taxes. This is for informational purposes only.
(1) Kagan Julia (2022). “Tax Evasion. Tax Evasion Definition (investopedia.com).”
(2) Kemmerer David (2022). “The Ultimate Crypto Tax Guide (2022). The Ultimate Crypto Tax Guide (2022) | CryptoTrader.Tax.”