Crypto Taxes in 2021
The Taxation of Cryptocurrency
It is important to know that pursuant to guidance issued by the IRS (Notice 2014–21), the IRS treats cryptocurrencies (they use the term “virtual currencies”) like Bitcoin, Ethereum, AAVE and UNI as property for tax purposes.
This means that crypto transactions in which you sell crypto for fiat currency, trade BTC for ALTs or ALTs for BTC, or use crypto to buy goods or services will trigger a taxable event. These transactions will result in either a capital gain or a capital loss, depending on whether your crypto investment appreciated or depreciated prior to the taxable event.
The amount of tax that you will eventually pay depends on your effective tax rate for federal taxes, which is dependent upon your taxable income for the year. Of course, state taxes vary throughout the country, and those rates must be taken into consideration. In addition, the amount of tax that will ultimately become due with respect to virtual currency transactions during the year depends on whether capital gains were short term or long term. This is dictated by the holding period of the cryptocurrency involved in the taxable transaction.
If a taxpayer does not have capital gains on the year, but rather has incurred a net capital loss, they will be able to utilize those losses to offset taxable income for the year. A taxpayer may deduct up to $3,000 from their income, and if they ended up having a year where more than $3,000 of loss was incurred, those excess capital losses can be carried forward indefinitely until the unused deductible capital loss is used up. This could be in the form of offsetting future capital gains, or being used to offset $3,000 of future income if there was more capital loss incurred or no more capital activity.
In addition to capital activity, crypto transactions in the form of mining, staking, airdrops, or earned interest will result in ordinary income and will be taxed at ordinary income tax rates (meaning no potential benefit of long-term capital gain).
To recap, the following transactions will trigger taxable events:
- Selling crypto for fiat currency (i.e. USD)
- Trading BTC for ALTs or ALTs for BTC
- Using crypto to buy goods or services
- Receiving crypto from staking or lending activity
Understanding Cryptocurrency Taxation
While many crypto transactions trigger taxable events, there are crypto transactions that do not result in any tax being incurred, meaning there would be no taxable income at that point in time.
For example, buying and holding crypto, sending crypto from one wallet under your control to another wallet under your control, or using your appreciated crypto asset as collateral for a loan on a lending platform like Celsius does not trigger a taxable event.
Utilizing lending platforms allows taxpayers to borrow funds using their crypto assets as collateral. This results in no tax on the crypto that is being used as collateral, as long the tokens put up as collateral are not sold or exchanged.
Filing Your Cryptocurrency Taxes
Many crypto traders transact across a number of exchanges, both centralized and decentralized. Some of these exchanges are no longer in existence, which leads to traders not having access to all of their trading data. Reporting income from cryptocurrency transactions becomes a headache when data is missing. It is very difficult to calculate capital gain and loss activity because the missing transactions will impact the ability to keep track of cost basis, which directly impacts the ability to determine gain or loss on the disposition of a crypto asset.
It is VERY important to maintain clean records of all transactions so that any position that is taken on a tax return can be substantiated. While cryptocurrency exchanges do not necessarily have the infrastructure to provide you with 1099-Bs that you would ordinarily receive from a legacy brokerage, it is relatively straightforward to extract the data that is necessary to properly reconcile your activity for crypto taxes.
Crypto Tax Return
Your crypto tax income or loss activity will be reported on a variety of different tax forms.
Capital gains and losses get reported on IRS Form 8949, which will then roll up to Schedule D. This taxable income will ultimately be reflected on the front of your Form 1040.
Income that is generated from activities deemed to be ordinary, such as mining, staking, earning interest, or getting paid for services in crypto are each reflected in a different manner.
For example, income earned from staking or interest earned from lending is typically reported on Schedule B for crypto tax purposes. Mining income would be reported on Schedule 1 as other income, unless the taxpayer is in the business of mining. In the case of a business, the activity would be reported on Schedule C (which is the same treatment that receiving crypto as a method of payment for services would typically be treated).
Crypto Tax Professionals
At Taxing Cryptocurrency, we have been filing crypto tax returns dating back to 2013. We have reconciled millions of transactions on the blockchain and have filed hundreds of tax returns. The more complex your crypto tax situation gets, the more likely it is that you will need crypto tax advice and guidance. Whether we are assisting our clients with the reconciliation process, or strategizing and implementing our plans for a potential disposition, Taxing Cryptocurrency has the experience and expertise necessary to guide our clients through the complexities that the crypto market imposes on their crypto taxes.
FAQ’S
How do you calculate capital gains on cryptocurrency?
In order to calculate capital gains and losses, you must first know what your cost basis is in the asset that is being sold. Remember, digital currency is deemed a capital asset in your hands when held for investment. If the total USD fair market value of the asset has gone up from the initial purchase price, you will have a gain on the sale of your property. If the total USD fair market value of the asset has gone down from the initial purchase price, you will have a loss on the sale of your property. It is important to note that your BTC value of the trade can go down and you can have a USD gain on the sale of your coin. Alternatively, the BTC value of your trade can go up and you can still have a USD loss on the sale of your coin.
How do you calculate basis in cryptocurrency?
Your basis in a coin is the amount that you paid in dollars to acquire the coin. The cost basis is the cost that you paid for the cryptocurrency. It is important to have access to all of your trading history and virtual currency transaction history, or else there will be gaps in the data. This will cause tokens to appear to have “0” cost basis. This will lead to an overstatement of income on your tax return.
What is considered a taxable event when dealing with cryptocurrency?
A taxable event occurs after a sale or disposition of an asset. A taxable event also occurs when crypto is used to buy goods or pay for services. This is because an individual will either have an increase or decrease in purchasing power with their tokens from the appreciation or depreciation of their crypto asset, which will in turn lead to a capital gain or loss.
What are realized gains and losses?
Crypto assets often go up and down on a daily basis. For tax purposes, a taxpayer does not care about what happens during the period of time that they are holding an asset. All of the activity that occurs prior to a taxable event is merely unrealized gain or loss and does not have a tax impact.
For example, every time your ALT dumps, but you still are holding on to the token, there is no tax that is triggered. This is merely an unrealized loss. However, once the ALT is sold for either USD, BTC, or another ALT, a loss will have been realized and can now be recognized for tax purposes. This works in a similar manner when the ALT goes up.
Quick numerical example: Assume you invest $2,000 in BTC on Coinbase. During the year, the value of that BTC climbs to $20,000. You continue to hold on to the token and do not sell any BTC. The taxpayer has a $18,000 unrealized gain, and no taxable event has occurred. If the value of that BTC falls to $10,000 and the taxpayer then sells the BTC for USD, the taxpayer now has recognized a gain (or profit) of $8,000, which is a capital gain and subject to capital gains taxes.
