How Are Your Bitcoin Investment Gains Taxed?

Bitcoin and other cryptocurrencies are considered digital assets by the IRS and are therefore subject to taxation. The amount of tax you pay on your crypto investments depends on several factors, including the type of transactions you make, how much you earn, and how long you hold your assets. In general, if you sell or dispose of your crypto for a profit, you will be taxed on the capital gains, and if you receive crypto as payment for goods or services, it will be taxed as business income. It's important to keep detailed records of your transactions and consult with a tax professional or accountant to ensure you're complying with the relevant tax laws and regulations.

Capital gains and income tax

The tax rate on your Bitcoin gains depends on how long you held the asset and your total income. The IRS treats cryptocurrencies as property for tax purposes. This means that you pay taxes on cryptocurrency if you sell or use your crypto in a transaction, and it is worth more than when you purchased it.

Capital Gains Tax

If you sell or dispose of cryptocurrency, you'll pay capital gains tax, just as you would on stocks and other forms of property. The tax rate is 0–20% for crypto held for more than a year and 10–37% for crypto held for less than a year.

Income Tax

If you earn cryptocurrency through your job, mining, staking, or airdrops, you'll pay income tax on it. The rate depends on your income level and ranges from 10–37%.

Long-Term Capital Gains Tax

If you sell crypto after owning it for more than a year, you'll pay long-term capital gains tax. The rate depends on your income and filing status and is generally between 0%, 15%, or 20%.

Short-Term Capital Gains Tax

If you sell crypto within a year of purchasing it, you'll pay short-term capital gains tax, which is higher than the long-term rate. Any profits from short-term capital gains are added to your taxable income for the year, and you calculate your taxes based on that amount.

Crypto Tax Software

To make filing your crypto taxes easier, you can use crypto tax software that connects to your crypto exchange and compiles the necessary information for you.

Taxable events

Bitcoin and other cryptocurrencies are taxed when a taxable event occurs. A taxable event is when you spend, sell, trade, or dispose of your cryptocurrency and it has increased in value since you acquired it.

• Selling your cryptocurrency for fiat currency
• Using your cryptocurrency to purchase goods or services
• Trading your cryptocurrency for a different type of cryptocurrency
• Receiving cryptocurrency as payment for goods or services
• Mining or staking cryptocurrency
• Receiving airdropped tokens
• Getting paid in cryptocurrency
• Receiving interest or yield in cryptocurrency

It's important to note that not all activities involving cryptocurrency are taxable events. For example, buying cryptocurrency with fiat money, transferring it between wallets, or gifting it to someone else are not considered taxable events.

When a taxable event occurs, you need to report the gains or losses on your tax return. The amount of tax you pay will depend on various factors, including your income level, the length of time you held the cryptocurrency, and your tax filing status.

Tax reporting

The IRS treats cryptocurrencies like Bitcoin as property for tax purposes. This means that any time you dispose of your crypto, you may need to pay a Capital Gains Tax. Disposing of crypto includes selling crypto for fiat currency, trading crypto for other cryptocurrencies, and spending crypto on goods and services.

You'll pay Capital Gains Tax on any capital gain (profit) you make as a result of a disposal. The tax rate depends on how long you've held your crypto and how much you earn. If you've held your crypto for less than a year, you'll pay the short-term Capital Gains Tax rate, which is the same as your income tax rate. If you've held your crypto for more than a year, you'll pay the long-term Capital Gains Tax rate, which is lower for most taxpayers.

To calculate your capital gain, subtract the cost basis (the amount you paid for the crypto plus any associated fees) from the sale price. If you have a gain, you'll pay Capital Gains Tax on that amount. If you have a loss, you won't pay Capital Gains Tax, but you can use this loss to offset other capital gains, potentially reducing your overall tax bill.

In addition to Capital Gains Tax, you may also need to pay Income Tax on certain crypto transactions. For example, if you get paid in crypto by your employer, your crypto will be taxed as compensation according to your income tax bracket. Mining crypto or receiving crypto through staking or an airdrop is also generally taxed as income.

To accurately report your crypto taxes, you'll need to keep detailed records of your transactions, including the date of each transaction, the fair market value of the crypto in USD at the time of the transaction, and the capital gain or loss from each transaction. Crypto tax software like Koinly can help you track and organize this data.

When filing your taxes, you'll need to report crypto disposals, capital gains, and losses on Form Schedule D (1040) and Form 8949. Crypto income should be reported on Form Schedule 1 (1040) or Form Schedule C (1040).

Tax deductions

Capital Losses

If you sell Bitcoin for a loss, you can write off these capital losses on your tax return, which may help reduce your overall tax burden. The process for deducting capital losses on Bitcoin is similar to that of losses from stock or bond sales. The maximum amount that can be deducted in a year is $3,000, and any net losses exceeding this amount can be carried forward into future years.

Tax-Loss Harvesting

Tax-loss harvesting is a strategy where investors sell assets, such as Bitcoin, at a loss to realise the tax benefits. By doing so, investors can offset capital gains and reduce their taxable income. This strategy is particularly advantageous for Bitcoin due to its exemption from the wash-sale rule, which prohibits traders from immediately buying back the same stock after selling it for a loss.

Long-Term Capital Gains

Holding Bitcoin for more than a year before selling can result in lower tax rates. Long-term capital gains taxes are typically lower than short-term capital gains taxes, so investors can reduce their tax liability by holding their Bitcoin for the long term.

Charitable Giving

Donating Bitcoin to charitable organisations can also provide tax benefits. In some countries, charitable giving is considered an altruistic exercise, and donors may be eligible for tax deductions or returns. However, it is important to familiarise yourself with the established norms and regulations surrounding charitable giving and tax deductions in your specific country or region.

Itemised Deductions

Itemised deductions can help reduce your overall tax bill. Examples of itemised deductions include amounts paid for cryptocurrency donations, mortgage interest, and state or local taxes. However, it is important to note that itemised deductions will only reduce your tax bill if they exceed the standard deduction available.

It is always recommended to consult with a certified accountant or tax professional familiar with cryptocurrency taxation to ensure accurate reporting and compliance with the relevant regulations.

Tax evasion

Bitcoin and other cryptocurrencies are subject to taxation, and failure to report crypto on tax filings may result in steep penalties. The Internal Revenue Service (IRS) considers crypto to be property for tax purposes, and any profits or income from cryptocurrency are taxable.

Crypto Tax Evasion

The IRS defines two types of crypto tax evasion:

• Evasion of assessment: This is the more common type, where a taxpayer willfully omits or underreports income, or overstates deductions. Examples include not reporting capital gains from sales or other dispositions of crypto, not reporting additional income received in cryptocurrency, and not reporting wages paid in cryptocurrency.
• Evasion of payment: This occurs when a taxpayer conceals assets or funds that could be used to pay off their tax liability after a tax assessment has been made. This type of tax evasion is less common in the crypto space but has occurred.

The punishments for crypto tax evasion can be severe, as both tax evasion and tax fraud are federal offenses. Offenders can face up to 75% of the tax due, with a maximum fine of $100,000 for individuals ($500,000 for corporations) or up to 5 years in prison.

How to Avoid Crypto Tax Evasion

The IRS has multiple methods to track crypto transactions and identify tax evasion. They have gained information about crypto users by issuing subpoenas to crypto exchanges and receiving user data through IRS 1099 forms. Additionally, the IRS is adding 87,000 agents who will be trained in data-matching blockchain transactions with anonymous wallets.

To avoid crypto tax evasion, it is important to understand your tax obligations and accurately report any crypto-related income or transactions. If you have previously failed to report crypto on your taxes, you can use Form 14457 to voluntarily disclose this information to the IRS and avoid criminal proceedings.

Frequently asked questions