So you decided to join the wave and take the plunge on cryptocurrency last year with an investment in Bitcoin (BTC), Ethereum (ETH), or maybe another smaller coin or token. Depending on when you entered the volatile crypto market you may be sitting on some nice profits or a substantial loss.
As cryptocurrencies become more and more mainstream, the Internal Revenue Service (IRS) is making sure to get its share of any capital gains or losses for the year. So, what are the relevant tax policies for that sweet trade you made on Dogecoin (DOGE) back in April?
How are Cryptos Treated?
Cryptocurrencies are a digital asset that can be used to buy goods and services that operate as a decentralized medium of exchange with no need for a central authority through the use of blockchain technology. Many crypto projects are treated as a form of virtual currency but the IRS treats crypto as a property. Thus, cryptocurrency holdings need to be reported as capital gains or losses with gains being either short or long-term depending on length of time holding the asset.
Investments in crypto that are held for less than one year are treated as short-term gains and are treated the same as ordinary income (up to 37% in 2021). Meanwhile, long-term gains that are held for more than one year are taxed at thresholds of either 0%, 15%, or 20%. All of a sudden the quick buck made in Shiba Inu (SHIB) has less shimmer compared to the investor holding Bitcoin since 2020.
Mining and Payments Made in Crypto
Aside from just investing in crypto, miners who solve complex equations to verify and add cryptocurrency transactions to a blockchain also have to pay taxes for the crypto received as a result of that process. Any cryptocurrency received as a result of mining is simply treated as taxable income similar to being paid in dollars or another fiat currency. The crypto is then taxed at the fair market value of the cryptocurrency on the day payment was received.
Meanwhile, for people accepting cryptocurrencies such as Bitcoin as a form of payment for goods and services provided, the payment is also treated as taxable income. Similar to mining, the dollar value for tax reporting is equivalent to the fair market value of the cryptocurrency the same day it was received as payment.
Actually Using Crypto as a Form of Payment
Crypto tax implications get a lot more complicated though once individuals decide to actually use the platform as a form of payment for goods and services. Any cryptocurrency you receive and decide to sell or spend on later is treated as either a capital gain or loss just like stocks. Again although many consider crypto to be a form of currency, the IRS treats it as property so when you are holding cryptocurrencies it is considered an investment.
Thus, in many situations people are taxed twice for crypto transactions. If an individual receives Bitcoin as a form of payment and decides to use that coin to pay for a product or service, then the original value needs to be taxed as ordinary income and any change in value over the period held is taxed as either long-term or short-term capital gain depending on holding time. The same situation applies if the same individual sells the Bitcoin instead of using it to purchase another item.
For example, if Bob is paid $1,000 worth of Bitcoin in May and decides to use that coin to pay for a new $2,500 laptop in November, then the $1,000 is treated as taxable income while $,1500 is taxed at the short-term capital gains rate. Alternatively, if Bob just held the Bitcoin and hasn’t decided to spend or sell it yet, then the only transaction that needs to be reported this year is the $1,000 as taxable income.
Lastly, exchanging cryptocurrencies for other crypto projects is treated in the same manner as if it was sold or spent. The difference in value between the time purchased and exchanged for is treated as a capital gain or loss for tax purposes. Thus, if Bob converted the original $1,000 worth of Bitcoin to $2,500 worth of Dogecoin six months later, he would still need to pay capital gains tax for the $1,500 difference.
Wrapping Up
Paying taxes is never a fun or easy process and that holds especially true for those who make money in a variety of ways. Cryptocurrencies are not some tax haven that is exempt from traditional investment taxations because it's considered a form of payment. Investors will still need to fork over some of those gains made over the year but at least it’s not yet treated as some entirely new asset with its only unique set of complicated tax compliances.
