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How To Calculate Your Crypto Taxes

09.11.2020

Calculating and filing taxes can be intimidating, and this can be especially true for any taxpayer who also has to pay taxes on their cryptocurrency.

Since taxpayers have to report all gains and losses on every cryptocurrency transaction, it is important to understand the cryptocurrency taxation process.

In this guide, we will highlight how the IRS views cryptocurrencies, what cryptocurrency transactions qualify to be taxed, and the easiest ways to track and submit all of your cryptocurrency trading information.

How Are Cryptocurrencies Taxed?

In the United States, the Internal Revenue Service (IRS) is responsible for collecting all Americans taxes and making sure that everyone is paying the correct amount they owe. This includes cryptocurrency transactions, as the IRS wants to collect all the revenue they are owed from all assets. The IRS views all cryptocurrencies and digital assets as a form of property, meaning that property taxation rules apply to cryptocurrency transactions. Even though many people use cryptocurrencies as a transactional currency, the IRS does not view cryptocurrencies in this way when it comes to taxes.

Which Cryptocurrency Transactions Are Taxable?

Since the IRS has determined that all cryptocurrencies are to be treated as property, every transaction someone makes, whether it is for a gain or loss, is considered a taxable event and should be reported to the IRS. Knowing this, it is important to keep track of all of your cryptocurrency trading information and activity. The IRS does not accept cryptocurrencies as a way of paying taxes, so it is important to track your records in U.S dollar terms, as this is how the IRS expects people to pay.

In the eyes of the IRS, if someone makes a transaction for a gain or loss, it is considered a capital gain or a capital loss and will be taxed the same way as other types of property, such as stocks, bonds, or real estate. If you are unsure whether the cryptocurrency transaction you made is taxable, you can look on the IRS website, where they have a lot of information dedicated on how to pay your cryptocurrency taxes and what they expect from taxpayers.

Besides being taxed on cryptocurrency transactions made during the year, you can also be taxed on any cryptocurrencies you’ve earned. This usually refers to earning cryptocurrencies through cryptocurrency mining, but it can also be applied to getting paid in cryptocurrency. The IRS also considers airdrops as earning cryptocurrency, so if someone receives any cryptocurrencies in an airdrop, they should report the value they received to the IRS. Similarly to trading cryptocurrencies, the IRS wants taxpayers to report all of their cryptocurrency income in U.S. dollars, so it is best to track mining profits or cryptocurrency income in U.S dollars. Cryptocurrency income is not taxed as property when it is received, but as income, so it may be taxed at a different percentage depending on the taxpayer’s annual income.

Cryptocurrency Tax Examples

Calculating the taxes someone owes on cryptocurrency is determined the same way it would be with any other asset considered property. The taxpayer has to subtract the starting purchase amount from the final sale price to determine how much in taxes they owe from each transaction. 

For example, if someone purchases 0.5 Bitcoin for $5,000 in January and sells the 0.5 Bitcoin in May for $7,500, they will have to pay capital gains taxes on the $2,500 profit made from the transaction. Alternatively, if someone bought 0.5 Bitcoin in January for $5,000 and sold the 0.5 Bitcoin in May for $3,000, they will have a $2,000 capital loss that they can report to the IRS.

Since receiving cryptocurrency as payment is taxed differently then cryptocurrency transactions, the formula for calculating the taxes owed is different. When you receive cryptocurrency as a payment, it is taxed the same way as other forms of income. For example, if you receive $50 worth of Bitcoin for 1 hour of work, you have to pay income tax on the $50 you earned. In this case, the IRS wants you to report income in U.S. dollars, so there is no difference in receiving $50 worth of Bitcoin or $50 worth of cash, as the income tax owed will be the same. If you get paid $50 worth of Bitcoin and hold it until the value doubles to $100, once you sell it for $100 you also owe capital gains taxes on the additional $50 profit you made from trading.

Cryptocurrency Taxation Tips

Calculating cryptocurrency taxes may seem a little scary, but some tips and tricks can be used to make the process as easy as possible. The first tip is to stay as organized as possible. The first step to staying organized and tracking all your transactions is to safely store all of your cryptocurrency wallet and exchange information. Sometimes, users may use a very small or obscure cryptocurrency exchange, or use different wallets for different types of cryptocurrencies; it is important to track all of your cryptocurrency holdings properly so you can pay the right amount of taxes you owe. If you stay organized throughout the year, it is much easier to find and calculate all the information you need once tax season arrives.

Another tip is to use your cryptocurrency capital losses to your advantage by reducing your taxable income. If you are currently holding depreciating assets you can use this to your advantage with tax loss harvesting. This means that you can sell the cryptocurrency for a loss and rebuy the cryptocurrency at the same price so that you can claim the loss for tax purposes while still maintaining your holdings. With this method you might spend a little more in trading fees, but you can save a lot more money by reducing your yearly taxable income.

A final tip is to automate your cryptocurrency tax reporting to make the process as easy as possible. There are many different cryptocurrency tax platforms which do almost all of the work for you. With cryptocurrency tax software, you can compile and upload all of your cryptocurrency activity and have the software handle all the calculations and reporting for you. For many, this can make cryptocurrency tax reporting a lot less stressful.

For more details on specific crypto tax scenarios, reference this tax guide.

Key Takeaways

Keeping track of every cryptocurrency transaction and reporting them on time is important to stay in good standing with the IRS. The IRS has increasingly focused on cryptocurrency traders, so it is important to be as accurate as possible when submitting cryptocurrency taxes. There are many tools available that make tracking and calculating your cryptocurrency taxes easier, and there are even some tricks you can use to lower your tax basis. Even though taxpayers have to report every single cryptocurrency transaction, whether that is a trade, purchase, or payment received, there are a lot of methods that can be used to simplify the process.

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