Crypto Tax Strategies: Deducting Your Investments

Investing in crypto is a hot topic in the financial news. It's important to know how it's taxed so you can focus on strategies to minimize how much crypto tax you'll have to pay. The IRS treats cryptocurrencies as property, and investors will need to report it as such on their tax returns. Crypto is taxed as a capital asset, similar to stocks and bonds. So, when someone uses, sells, or is paid in crypto, they generally have to pay taxes on their realized gains. However, not all crypto transactions result in a tax liability. These nontaxable events include buying crypto with cash, holding it, donating it to a qualified charity, or transferring it between wallets or accounts.

Crypto as property

The IRS treats cryptocurrencies as property for tax purposes. This means that if you sell or use your crypto in a transaction, and it is worth more than when you bought it, you will need to pay taxes on the increased value. This is because you trigger capital gains or losses if its market value has changed.

Cryptocurrency is considered "property" for federal income tax purposes. For the typical investor, the IRS treats it as a capital asset. As a result, crypto taxes are no different from the taxes you pay on any other gain realised on the sale or exchange of a capital asset.

Per IRS Notice 2014-21, cryptocurrencies are taxed like capital assets (similar to stocks and bonds) vs. a currency. As such, cryptocurrencies can be classified as business property (in the case of mining), investment property, or personal property. This means that you will be taxed only if you sell your assets for a profit.

The IRS stance (cryptocurrency is property) treats gains and losses as capital in nature. Thus, report gains as either short-term or long-term capital gains. Since any "property train" runs both ways, cryptocurrency losses show up on a Form 1040 as either short-term or long-term capital losses.

Cryptocurrency taxes are complicated because they involve both income and capital gains taxes. In most cases, you're taxed multiple times for using cryptocurrency.

Crypto as income

In the US, the IRS treats cryptocurrency as a digital asset, and taxes it as property. This means that any crypto income is taxed as ordinary income at its fair market value on the date it is received.

• Receiving crypto as payment for providing a service
• Mining crypto and earning rewards
• Staking crypto and earning rewards
• Lending crypto and receiving interest payments

If you are paid in cryptocurrency by your employer, it will be taxed as compensation according to your income tax bracket. If you are an independent contractor, the fair market value of the crypto received, measured in US dollars, is subject to self-employment tax.

If you receive crypto from mining or staking, your cost basis is determined by the fair market value when you received it. If you receive crypto as a gift, your cost basis will depend on both the basis of the person who gave it to you and its fair market value when you received it.

If you are a US taxpayer, you will need to report your crypto income on your federal and state income tax. The crypto you receive as income is subject to these income taxes, which are often not deducted or withheld. When you report your earnings, you will generally owe according to the income tax rate appropriate to your tax bracket.

Crypto tax rates

The tax rate on cryptocurrency depends on how long you've held your assets and your income level.

Long-Term Capital Gains Tax

If you've held your cryptocurrency for more than a year before selling or using it, your profits are taxed at the long-term capital gains rate, which is lower than the short-term capital gains tax rate. The long-term capital gains tax rate ranges from 0% to 20% depending on your income level.

Short-Term Capital Gains Tax

If you've held your cryptocurrency for less than a year before selling or using it, your profits are taxed as ordinary income. The short-term capital gains tax rate ranges from 10% to 37% depending on your income level.

Ordinary Income Tax

If you earn cryptocurrency through your job, mining, staking, or airdrops, you'll pay ordinary income tax, which ranges from 10% to 37% depending on your income level.

Crypto Tax Brackets

It's important to note that most taxpayers don't pay a single flat tax rate on their entire income. Instead, they pay progressively higher tax rates on different portions of their income. For example, a taxpayer who earned $25,000 won't pay a flat 12% tax. Instead, they'll pay 10% on the first $11,600 and 12% on the next $13,400.

Crypto Tax Strategies

• Hold your crypto for at least a year to take advantage of the lower long-term capital gains tax rate.
• Use tax-loss harvesting to offset gains with losses. You can use up to $3,000 of capital losses to reduce your taxable income, and any remaining losses can be carried forward to future years.
• Sell your crypto in a low-income year to reduce your overall tax burden.
• Reduce your taxable income by taking advantage of tax deductions and credits, such as making charitable donations or contributing to a retirement account.
• Invest in a Self-Directed Individual Retirement Account (SDIRA) to defer taxes until retirement, when your income is likely to be lower.
• Gift your crypto to family members. You can gift up to $16,000 per person per year without tax consequences, and the recipient may be in a lower tax bracket.
• Donate your crypto to charity. This avoids capital gains taxes and triggers a tax deduction on your tax return.
• Move to a state with no income tax to avoid paying state-level taxes on your crypto gains.
• Bequeath your crypto in your estate. When you pass away, your crypto will receive a "step-up" in basis, and your heirs will not pay taxes based on your original purchase price.

Crypto tax forms

• Form 1040: This is the main form used to file 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 activity is taxable.
• Form 1040 Schedule D: This form is used to report capital gains and losses from the sale or trade of property during the tax year. Capital assets can include stocks, bonds, mutual funds, homes, and cryptocurrencies. You reconcile your capital gains and losses on this form and then report the total on Form 1040.
• Form 8949: This form is filed with Schedule D when you need to report additional information for the sale or exchange of capital assets like stocks, bonds, real estate, and cryptocurrencies. You can use this form to report the sale of assets that were not reported on Form 1099-B by your crypto platform or brokerage company, or to correct information that was reported. You then enter the total value from Form 8949 on Schedule D.
• Form 1099-MISC: This form is used to report certain payments received from a business other than non-employee compensation. It is often used to report income earned from participating in crypto activities like staking, earning rewards, or promotional incentives. Even if you don't receive this form, you still need to report this income on your tax return.
• Form 1099-NEC: This form is issued when a business pays a non-employee $600 or more in a year. Even if you don't receive this form, earnings are still taxable and need to be reported, including if you are paid in cryptocurrency.
• Schedule C: If you earned income, either in cryptocurrency or any other form of payment, and are not an employee, you are likely self-employed. You can use Schedule C to report income and expenses and determine your net profit or loss from the activity.
• Schedule SE: If your net profit is $400 or more, you will likely need to complete Schedule SE to calculate your Social Security and Medicare taxes.

It's important to note that not all crypto transactions result in a tax liability. For example, buying crypto with cash and holding it, donating it to a qualified charity, or transferring it between wallets or accounts are typically not taxable events. Additionally, if you bought, sold, or exchanged cryptocurrency through a tax-deferred or non-taxable account, this activity is usually not taxable, although you may be taxed when you withdraw money from the account.

Crypto tax deductions

Crypto Considered as Property

The IRS defines cryptocurrencies as digital assets and treats them as property for federal income tax purposes. This means that crypto transactions are taxed similarly to stocks, bonds, and other capital assets. It's important to note that this classification is not consistent across all federal government agencies.

Taxable Crypto Transactions

The following crypto activities are typically taxable:

• Selling crypto for cash: When an investor sells cryptocurrency for fiat currency and makes a profit, they will have to pay capital gains taxes on the proceeds.
• Using crypto to purchase goods or services: If an individual uses crypto to buy something, they will likely owe capital gains taxes as the crypto needs to be sold for dollars before it can be used for a purchase.
• Exchanging cryptocurrencies: Converting one cryptocurrency for another is considered a taxable event, and the investor may have to pay capital gains tax on the sale of the original crypto if it was sold for a profit.
• Being paid in cryptocurrency: If an individual is paid in crypto, they will need to pay income taxes on that income, depending on their tax bracket.
• Mining cryptocurrency: The proceeds from mining crypto are generally taxed as income, and in some cases, may be taxed as business income.
• Crypto acquired via an "airdrop" or "hard fork": New coins received through airdrops or hard forks are taxed as income.

Non-Taxable Crypto Transactions

Not all crypto transactions result in tax liability. The following activities are generally not considered taxable events:

• Buying crypto with cash: Purchasing crypto with fiat currency is not a taxable event.
• Holding crypto: Simply holding crypto without selling or exchanging it is not taxable.
• Donating crypto to a qualified charity: Donating crypto is tax-deductible and not subject to capital gains taxes.
• Gifting crypto: Gifting crypto to family or friends is generally not a taxable event, as long as the value is below the annual gift tax exclusion limit.

Crypto Tax Strategies

To minimize crypto taxes, investors can consider the following strategies:

• Hold for Long-Term Gains: Holding crypto for more than a year before selling can result in lower tax rates, as long-term capital gains tax rates are typically lower than short-term rates.
• Offset Capital Gains with Losses: Losses on crypto assets can be used to offset taxable gains on other investments, reducing overall tax liability.
• Sell in a Low-Income Year: Selling crypto in a year when your overall income is lower can help reduce the tax rate on both short-term and long-term capital gains.
• Reduce Taxable Income: Look for tax deductions and credits, such as contributions to a traditional IRA or 401(k), to lower your taxable income and potentially reduce crypto taxes.
• Invest in a Self-Directed Individual Retirement Account: Investing in a tax-deferred or tax-free SDIRA allows you to defer taxes until retirement or pay taxes upfront, depending on your expected tax bracket.
• Donate Crypto to Charity: Donating appreciated crypto to charity results in no capital gains tax and can trigger a significant tax deduction on your tax return.

Crypto Tax Reporting and Compliance

It is important to report crypto transactions accurately to the IRS. Most crypto exchanges will provide a transaction history, and investors should keep detailed records of all crypto activity. When filing taxes, investors will need to determine what is owed, record and report transactions, and file the correct forms, such as Form 8949 and Schedule D of Form 1040.

Frequently asked questions