Crypto and Taxes: What You Should Know

The IRS considers cryptocurrency to be property. This means that cryptocurrency income and capital gains are taxable, while cryptocurrency losses may be tax deductible. Crypto sales, conversions, payments, and income must be reported to the IRS and, where appropriate, state tax authorities in the United States, and each of these transactions has different tax ramifications. 

In certain circumstances, people must pay taxes on cryptocurrency. The IRS has regarded cryptocurrencies as property since 2014. Taxpayers must report transactions involving virtual currency as U.S. dollars on the tax returns, which means they should determine its fair market value during the transaction date. 

Furthermore, purchasing something with Bitcoin is taxable because the person disposes of cryptocurrency to make a purchase, which differs from traditional currencies. If the virtual currency’s exchange rate is determined by market supply and demand, you can calculate fair market value by changing it into dollars or another currency that can be turned into dollars.

Type of Crypto Transactions Classified For Tax Purposes

• If You Owned or Used Cryptocurrency 

You must report any cryptocurrency transactions on your tax return. Form 1040 asks taxpayers towards the top if they received, sold, transmitted, swapped, gifted, or otherwise disposed of a digital asset during the tax year.

So you’re on the hook to answer whether you’ve transacted in cryptocurrencies, perhaps placing you in a position to lie to the IRS. If you do not answer truthfully, you may face additional legal consequences, and the IRS does not look lightly on liars and tax cheats.

• Selling cryptocurrency

When you sell cryptocurrency, the gain or decrease in value is taxed. This type of transaction is classified as capital gains and is usually straightforward, especially if you don’t purchase and sell cryptocurrency regularly.

These sums are determined in the same manner as other capital gains and losses. You compute how much the currency has risen or fallen since your cost basis (the amount you paid for it). However, selling property as part of a business or trade is not considered a capital asset and is taxed as ordinary income. 

• Exchanging one cryptocurrency for another 

Without first converting your cryptocurrency to cash, you can exchange one cryptocurrency for another directly. Because cash was not realized, this type of transaction is frequently overlooked regarding taxes. However, it is a taxable event if you swap Bitcoin for Litecoin or Ethereum.

• Giving a gift

Giving is tax-free, up to $15,000 per recipient yearly. You must submit a gift tax return if your gifts to each recipient exceed $15,000; doing so typically results in no current tax burden. Even if you didn’t intend it to be a gift, transferring cryptocurrency to someone else without paying for goods or services may be a gift.  

• Inherited Cryptocurrency

Cryptocurrency passed down from generation to generation is treated similarly to other capital assets. If the estate exceeds specified criteria ($12.92 million in 2023), they can be liable to estate taxes. Like stocks, bitcoin has a cost basis that is increased to its fair value on the day of death. According to Harris, most individuals similarly treat cryptocurrencies to other types of capital assets.

• Receiving or using cryptocurrency as payment

Cryptocurrency can be sent through a crypto wallet and is used as payment by some individuals and organizations. If you receive payment in cryptocurrency from a customer in return for products or services, this money is regarded as taxable income. The fair market value of the cryptocurrency on the day and time you received payment, converted into U.S. dollars, is the taxable amount.

Important Takeaway

Cryptocurrency is classified as property or a digital asset by the IRS. It is a taxable event whenever you sell or exchange cryptocurrency. This includes the use of cryptocurrency to pay for goods or services.

In most circumstances, cryptocurrencies are taxed as an asset and subject to long-term or short-term capital gains taxes. However, bitcoin is occasionally recognized as income. Keep track of all your cryptocurrency transactions to avoid a rude surprise at tax time.

It can be surprising to use bitcoins, from tracking your cost basis to noting your effective realized price and even owing tax (even with an official Form 1099 letter). Furthermore, the IRS is increasing its enforcement and surveillance of potential tax avoidance by closely monitoring who exchanges cryptocurrency. These characteristics make cryptocurrencies more challenging to use and will likely hamper their widespread adoption.