Crypto Investing: Debt Risk And You

Investing in cryptocurrencies is risky and speculative, and it's possible to lose money. In fact, one of the biggest obstacles for people interested in investing in crypto is the fear of losing all their money. While it's not possible to lose more money than you invest, it is possible to lose your initial investment. This can happen through a variety of means, including investing in a Ponzi scheme, or if an exchange you use becomes insolvent and your withdrawal is deemed a preferential transfer. Additionally, there are legal and tax implications to investing in cryptocurrencies that vary by jurisdiction. For example, in the US, the IRS treats cryptocurrencies as property, and any profits made from their sale are subject to capital gains tax.

Crypto taxes

In the United States, the Internal Revenue Service (IRS) considers cryptocurrency a digital asset and treats it similarly to stocks, bonds, and other capital assets for tax purposes. This means that any gains or profits you make from crypto investments are generally subject to capital gains tax or income tax, depending on how you acquired and held your crypto.

Taxable Events

There are several scenarios that trigger a taxable event in crypto:

• Selling crypto for cash: When you sell your crypto for fiat currency, you'll owe taxes if you make a profit. If you sell at a loss, you may be able to claim a capital loss deduction.
• Converting one crypto to another: Converting one cryptocurrency to another is considered a taxable event by the IRS, as you are technically selling one asset to buy another.
• Spending crypto on goods and services: Using crypto to buy goods or services is treated similarly to selling it, and you'll likely owe capital gains taxes on any profits.
• Getting paid in crypto: If you receive crypto as payment from an employer, it's taxed as compensation according to your income tax bracket.
• Mining or staking crypto: Any crypto you earn through mining or staking is generally taxed as income based on the fair market value of the coins at the time you received them.
• Earning airdrops or rewards: Receiving crypto through airdrops, rewards, or incentives is considered taxable income.

Non-Taxable Events

On the other hand, there are also some scenarios that are typically non-taxable:

• Buying and holding crypto: Simply buying and owning crypto is not a taxable event. Taxes are usually incurred when you sell or dispose of your crypto.
• Receiving crypto as a gift: If you receive crypto as a gift, you generally won't owe taxes until you sell or engage in another taxable event.
• Transferring between wallets: Transferring crypto between wallets or accounts you own is generally not taxable, although you may pay taxes on any transaction fees.
• Donating crypto: Donating crypto to qualified tax-exempt charities or non-profits may allow you to claim a charitable deduction.

Calculating Crypto Taxes

Calculating your crypto taxes can be complex, and it's important to consult a tax professional for personalized advice. However, here are some key considerations:

• Cost basis: Your cost basis is the amount you paid for the cryptocurrency, including any fees. This is used to calculate your capital gains or losses when you sell or dispose of your crypto.
• Holding period: The length of time you hold your crypto before disposing of it affects your tax rate. In the US, long-term capital gains (holding for more than a year) are typically taxed at a lower rate than short-term capital gains.
• Income tax bracket: Your personal income tax bracket also impacts the tax rate you pay on crypto income and gains.

Reporting Crypto Taxes

It's important to keep detailed records of all your crypto transactions to accurately report them on your tax returns. Major crypto exchanges often send 1099 forms to the IRS, and you may need to file additional forms such as Form 8949 for capital gains and Schedule 1 for crypto income.

Crypto Tax Software

Due to the complex nature of crypto taxes, many investors turn to crypto tax software or seek the help of tax professionals with experience in this area. These tools can help automate the process of tracking transactions, calculating gains and losses, and preparing the necessary tax forms.

Crypto as property

In the US, the Internal Revenue Service (IRS) has defined cryptocurrencies as property, not currency. This means that individual investors are subject to capital gains tax laws when reporting cryptocurrency profits and expenses on their annual tax returns. If you are an employee and receive cryptocurrency as a salary, it is taxable as income. The amount is based on the value in US dollars of the cryptocurrency at the time it was paid.

The classification of cryptocurrencies as property rather than currencies has significant implications for investors. It means that any profits made from trading cryptocurrencies are subject to capital gains tax laws. This is in contrast to traditional currencies, where profits made from foreign exchange trading, for example, may be subject to different tax treatments depending on the jurisdiction.

The tax definition of a digital asset is any digital representation of value recorded on a cryptographically secured, distributed ledger (blockchain) or similar technology. Examples of digital assets include convertible virtual currencies and cryptocurrencies such as Bitcoin and non-fungible tokens (NFTs).

The classification of cryptocurrencies as property also has implications for businesses that accept them as a form of payment. Businesses that only accept cryptocurrencies, for example, may not need to register or obtain licenses at all, while they may be subject to special considerations depending on their jurisdiction.

Capital gains

In the U.S., cryptocurrency profits are subject to capital gains taxes, similar to stocks. Capital gains taxes are applied at both the federal and state levels. The rate of tax depends on how long you've owned the crypto and your income.

If you sell crypto for less than you bought it for, you can use those losses to offset gains made elsewhere. If your losses exceed your gains, you can use the additional amount to reduce your taxable income, up to $3,000 in most cases. Any remaining losses can be carried over to future years.

If you own crypto for one year or less before selling, you'll pay the short-term capital gains tax, which is higher than the long-term rate. Short-term capital gains are taxed as ordinary income, with rates ranging from 10% to 37%.

Long-term capital gains tax is applied if you sell crypto after owning it for more than a year. The long-term capital gains rates are 0%, 15%, or 20% at the federal level, depending on your income.

It's important to note that you're only taxed on cryptocurrency if you sell it, whether for cash or another cryptocurrency. Simply buying and owning crypto is not taxable. However, if you receive crypto as payment for goods or services, it's considered income and must be reported to the IRS.

Crypto and foreign bank accounts

When it comes to crypto, there is some uncertainty among tax professionals. The IRS has not provided clear guidance on whether foreign crypto exchanges need to be reported on Form 8938. However, it's important to note that the IRS considers cryptocurrencies as property, and any gains from crypto transactions are generally taxable.

To stay compliant, it is recommended to report all cryptocurrency accounts, especially as there are no additional tax consequences and the process is relatively simple. The FBAR report, FinCEN form 114, can be filed electronically and requires basic information such as name, address, account numbers, and the highest value of the account during the year.

Additionally, it's worth considering the benefits of using offshore companies to hold crypto. Registering a digital account associated with crypto to an offshore company can provide an extra layer of separation between the individual and their crypto assets, potentially increasing privacy and protection.

Overall, the topic of crypto and foreign bank accounts is evolving, and it is advisable to seek the most up-to-date information and consult with tax professionals or experts in this field.

Crypto fraud

The most common type of crypto scam is the "pig butchering scam", where scammers establish a relationship with the victim, gain their trust, and then convince them to invest in fraudulent crypto opportunities. These scams often involve fake crypto trading platforms, where victims are unable to withdraw their funds and are asked to pay various fees and taxes. Other types of crypto scams include advance fee scams, asset recovery scams, bait-and-switch scams, crypto blackmail scams, fraudulent trading platforms, hacking, high-yield investment programs, identity theft, imposter scams, liquidity mining scams, livestream scams, romance scams, and tech support scams.

It is important for individuals to be vigilant and cautious when investing in crypto to avoid falling victim to these scams.

Frequently asked questions