Invest In Crypto: Pre-Tax Dollar Strategies For Beginners

Investing in crypto with pre-tax dollars is a complex process that requires careful consideration of various factors. Firstly, it's important to understand that the Internal Revenue Service (IRS) treats cryptocurrency as property, not as a currency. This means that any gains or losses from crypto transactions are generally subject to capital gains taxes. The tax rate depends on the duration of ownership, with short-term capital gains (held for less than a year) taxed as ordinary income, and long-term capital gains (held for more than a year) taxed at reduced rates. Additionally, any income from crypto transactions, such as mining or staking rewards, is taxed as ordinary income. It's crucial to maintain accurate records of all transactions and report them to the IRS using the appropriate forms, such as Form 8949 and Schedule D. While buying crypto is not a taxable event, selling, trading, or disposing of crypto triggers tax consequences. Therefore, it's important to consult with tax professionals and utilize crypto tax software to ensure compliance with tax regulations.

Crypto is taxed as property

The IRS treats cryptocurrency as a standard type of property, the same as receiving comic books or a car. The government taxes this asset as either ordinary income or capital gains. This means that if you sell it and make a profit, you will ordinarily owe taxes on those gains.

There are two ways that you can be taxed for cryptocurrency holdings. If you sell your cryptocurrency and realize a gain on it, this is considered a capital gain, the same as if you’d sold any other piece of property. Capital gains taxes are triggered whenever you sell something for more than its tax basis. The tax basis is the value of the asset at the time you received it. This means that any time you sell cryptocurrency, you can trigger capital gains taxes.

Income, Property Gain

When you increase your wealth by selling non-investment assets, the IRS considers it a taxable gain. This is what’s known as “ordinary income.” This holds true for cryptocurrency as well. You realize an ordinary loss or gain on cryptocurrency when you receive it in exchange for goods and services. When you receive cryptocurrency in exchange for goods or services, you must calculate the market value of the cryptocurrency at the time you receive it. This is your taxable gain.

This is also true if you spend cryptocurrency. If you exchange your cryptocurrency for something else of value, you trigger a taxable event that is taxed as ordinary income. In this case, you would owe the IRS the difference between the value of the cryptocurrency and the value of what you exchanged it for. Again, this is the same as all property transactions.

Ordinary income and capital gains income are taxed at two separate rates. As a general rule, capital gains taxes are considerably lower than ordinary income taxes.

You do not need to declare a taxable gain if you purchase cryptocurrency. This is true of all property. Buying an asset is considered a net-neutral exchange. A taxable event only occurs if you sell cryptocurrency for more than you paid for it, or if you receive cryptocurrency in exchange for labor, goods, or services.

While the specifics can differ, in most cases, you will be unable to avoid capital gains taxes if you own crypto and then sell it for profit. If you bought your crypto, your gains are calculated as the difference between what you paid and what you received. If you received your crypto in exchange for goods or services, your gains are calculated as the difference between the market value of the cryptocurrency when you received it and what you made from selling it.

You will owe ordinary income taxes if you received cryptocurrency in exchange for goods and services. In this case, your taxable status is the same as if you had exchanged any other two forms of property.

Capital gains and income tax

In the U.S., the IRS treats cryptocurrency as property, and it is taxed as either income or capital gains. Capital gains taxes are incurred when you sell crypto for a profit, and the rate of tax depends on how long you have owned the cryptocurrency and your income. If you have owned the crypto for a year or less, you will pay short-term capital gains tax, which is taxed as ordinary income. If you have owned the crypto for more than a year, you will pay long-term capital gains tax, which has its own system of tax rates.

Short-term capital gains tax rates range from 10% to 37%, and long-term capital gains tax rates can be 0%, 15%, or 20%. The higher your income, the higher your tax rate. It's important to note that short-term capital gains are taxed at a higher rate than long-term capital gains.

If you receive cryptocurrency as payment for goods or services, you will need to calculate the market value of the cryptocurrency at the time of receipt, and this will be your taxable gain. This also applies if you spend cryptocurrency. In this case, you will owe the IRS the difference between the value of the cryptocurrency and the value of what you exchanged it for.

If you receive cryptocurrency as income, for example, through mining or staking, you will need to report it as income and pay taxes on it.

Crypto losses can offset gains

Crypto losses can be used to offset taxes on gains from the sale of any capital asset, including stocks, real estate, and even other cryptocurrencies sold at a profit. In fact, if your capital losses exceed your capital gains, you may be able to use them to reduce your taxable income, further lowering your tax bill.

The IRS taxes cryptocurrencies under the capital gains provision of US tax law, just as it does other "capital assets" such as investment securities and real estate. When you profit from the disposition of an asset, the proceeds are considered capital gains and are subject to tax at a special rate. If you dispose of a capital asset for less than you paid for it, you incur a capital loss which may be deductible from your taxes.

The most straightforward way of disposing of a cryptocurrency is to sell it. Using cryptocurrency to buy goods, services, or other forms of crypto is also considered disposal. When you spend crypto, you must calculate any capital gains or losses incurred from the time you acquired the crypto to when you used it as payment.

It is important to note that you can only claim capital losses or gains that are realised through the process of disposing of cryptocurrency. If your cryptocurrency's value decreases before you sell it, that is not considered a capital loss. If the crypto issuer is working to revive the currency's value or it remains listed on at least one exchange, you haven't realised a loss and cannot claim one on your income tax return.

If you sell a portion of a cryptocurrency holding that you acquired over a span of time or in multiple transactions, the IRS permits you to use any of several methods to determine the cost basis used to calculate losses or gains:

• FIFO (first-in, first out): Uses the cost basis of the oldest batch of cryptocurrency tokens sufficient to satisfy the trade.
• LIFO (last-in, first out): Uses the cost basis of the most recently purchased tokens sufficient to meet the sale.
• HIFO (highest-in, first out): Uses the cost of the most expensive portion of tokens in your holdings as the cost basis.

Crypto losses can offset $3,000 of income and an unlimited amount of capital gains for the year. Additional losses can be rolled forward and offset gains and income in future tax years.

Crypto tax deadlines

Crypto investors must navigate a complex tax landscape. The IRS treats cryptocurrencies as property, not currency, and taxes them as such. This means that any time you sell, trade, or use crypto, you may trigger capital gains taxes. If you receive crypto as payment for goods or services, you realise an ordinary income gain, which is taxed differently.

The IRS has pushed back the tax filing deadline for 2023 to April 18, 2024. If you need more time, you can file IRS Form 4868 to extend your deadline to October 15, 2024. However, it's important to note that the extension only applies to filing, not payment—you must still pay any taxes owed by the original deadline, even if it's just an estimate.

If you don't pay your taxes on time, you may face penalties and interest. The failure-to-file penalty can be up to 5% per month, up to a maximum of 25%. The failure-to-pay penalty is 0.5% of the balance due, also up to a maximum of 25%. In addition, interest is charged on unpaid balances, currently at a rate of 8% for the first two quarters of 2024.

To avoid penalties, make sure to keep good records, carefully tracking the value of your crypto at the time of any transactions. You may also want to consult a tax professional, especially if you have a large number of transactions or are dealing with complex situations like DeFi or margin trading.

Crypto tax forms

The IRS treats cryptocurrency as "property" and not as a currency. As such, any gains or losses from the sale or exchange of cryptocurrency are taxed as property. The IRS has stepped up its crypto tax enforcement, so it is important to accurately calculate and report all taxable crypto activities.

• Form 1040: This is the main form used to file your income taxes with the IRS. It includes areas to report income, deductions, and credits, and it is used to gather information from other forms and schedules. Starting in tax year 2020, the IRS added a question about cryptocurrency activity at the top of Form 1040 to clarify that crypto transactions are taxable.
• Schedule D: This form is used to report capital gains and losses from the sale or trade of property, including cryptocurrencies. You would use this form to reconcile your capital gains and losses.
• Form 8949: This form is used to report additional information for the sale or exchange of capital assets, such as adjustments to the cost of an asset or expenses incurred during the sale. You would file this form along with Schedule D.
• Schedule C: If you earned income from crypto-related activities as a freelancer or independent contractor, you would use this form to report your income and expenses and determine your net profit or loss.
• Schedule SE: If your net profit from self-employment is $400 or more, you will need to complete this form to calculate your Social Security and Medicare taxes.

Other tax forms you may need for crypto-related income include Form 1099-NEC or 1099-MISC. These forms are used to report income from nonemployee compensation or miscellaneous sources, such as staking rewards or mining activities.

Frequently asked questions