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Dave Miller – Tech Enthusiast & Security Expert – January 11th, 2022
In 2021, cryptocurrencies went from basically zero to all-time highs. There were more than 10 percent of Americans who traded crypto last year, and you may be wondering how this activity may affect your taxes. Do you have to pay capital gains tax on crypto?
The Internal Revenue Service (IRS) and state tax authorities may compel taxpayers to disclose cryptocurrency sales, conversions, payments, and income, and each of these activities has its own tax consequences. This post will teach you when and how to pay taxes on your cryptocurrency.
For those who hold cryptocurrencies and aren’t sure what the tax implications are, keep reading. A better understanding of how bitcoin profits are taxed and the steps you may take to minimize your tax burden is critical if the capital gains tax rate is ever raised.
Investors in cryptocurrencies began to question what impact President Biden’s idea to raise capital gains tax on the wealthy would have shortly after he introduced it. For anyone making more than $1 million a year in investment income, a proposed rise in the long-term capital gains tax rate to 39.6 percent is drawing attention from crypto investors and others.
Using blockchain cryptography, cryptocurrency is a sort of virtual currency that encrypts transactions. In addition, there is no central bank in charge of keeping track of the amount of cash in circulation. Distributed digital ledgers rather than centralized electronic money or traditional paper money systems, known as fiat currencies, are used to safeguard and verify transactions in cryptocurrencies.
A common example of a fiat currency is the US dollar or the Euro. This blockchain technology functions like a constantly updated checkbook that is accessible to everyone, anonymously logging all transactions ever recorded. Coins like Dogecoin and Ethereum are also popular cryptocurrencies, but Bitcoin is the most well-known.
If you don’t want to buy cryptocurrencies via an exchange, there are other options. For example, in order to record data on the blockchain, certain cryptocurrencies employ “mining” to solve complex equations. Miners may be compensated with brand new crypto tokens as an added incentive to participate. An “airdrop” or marketing promotion on an exchange might potentially provide you with cryptocurrency.
Because cryptocurrencies like Bitcoin, Ether, and Dogecoin are treated as property, you must pay capital gains tax when you dispose of them (sell, trade, or use them as a way to obtain them.
Since cryptocurrencies have no official backing, many people point out that they are less regulated than traditional fiat currencies like the US dollar or Euro. There is a widespread misconception that bitcoin investors are engaging in secretive, anonymous transactions to avoid paying taxes as a result of this oversight.
True or false, this is not the case. According to the Internal Revenue Service (IRS), crypto exchanges must record user activity on gains and losses, and YES, you do have to pay capital gains tax on crypto because cryptocurrency is taxed in much the same way as traditional stocks or comparable assets. Because the IRS considers cryptocurrency to be “property,” it is subject to capital gains taxation.
If you sell or exchange a capital asset and realize a profit or loss, you’ll be taxed on that profit or loss. There are many examples of this, including when you buy a stock or other capital item. You begin a basis equal to your cost to acquire it.
Whether or not you’ve made a profit or lost money when you sell a capital asset is as simple as comparing the net sales proceeds to the initial basis. A capital gain occurs when the sale revenues exceed your original cost basis. A capital loss is locked in when the reverse is done.
It’s not enough to just compare your net profits to your cost basis when determining how much bitcoin taxes you owe. When determining whether or not you’ve made a capital gain or loss, you need also take into account the time period during which you held the asset. Your gains or losses in cryptocurrencies will be classified as “short-term” or “long-term” depending on how long you plan to retain it. The amount of crypto taxes you owe will be heavily influenced by this distinction.
A short-term capital gain or short-term capital loss is recognized when you buy and sell an asset within 365 days of each other, if the asset sells for more than what you paid for it. There are no special tax rates for short-term gains and losses; they are taxed at the same rates as ordinary earnings. In 2021, the IRS will have seven income tax bands, with rates ranging from 10% to 37%.
Investing for the Long Term Your net sales proceeds and your cost basis are long-term capital gains or losses if you sell an asset after a year. Tax rates are normally lower for long-term gains than for short-term ones, so you’ll pay less in taxes overall. Long-term capital gains are currently taxed at 0%, 15%, and 20%, respectively. The rate you pay is based on your income level.
Capital losses can also be used to offset capital gains. Gains and losses of one type must be used to establish the offset first. There are two types of losses: short-term losses and long-term losses. The other type of capital gain can be utilized to offset any residual net losses (e.g., remaining short-term losses can offset remaining long-term capital gains). You can deduct up to $3,000 of regular income from any remaining capital losses. In the following year, any residual capital losses are carried over.
Begin by figuring out your capital gains in order to figure out your cryptocurrency tax obligations (check out this article on crypto cost-basis for a walkthrough of this process).
Then, determine your tax rate. In order to determine your tax rate, you must consider the length of your holding period (called your holding period) as well as your income. Your tax rate will either be the same as your income tax rate or the long-term capital gains tax rate, depending on how long you held the asset. Holding periods and taxes: Let’s take a closer look.
Profits or gains made from the sale of cryptocurrency held for less than a year are subject to the short-term capital gains tax rate. The short-term capital gains tax rate is the same as the regular income tax rate, which can vary from 10% to 37%. Using the table below, you can determine your taxable income from any short-term capital gains and then apply the appropriate tax rate.
Whether you generate money through cryptocurrency mining, staking or airdrops or you get paid in crypto, all of your cryptocurrency-related income is subject to regular income tax.
2020 Short-Term Capital Gains Tax Rates | |||
Tax Rate | Tax Rate | Income – Married Filing Jointly | Income – Head of Household |
10% | $0 – $9,875 | $0 – $19,750 | $0 – $14,100 |
12% | $9,876 – $40,125 | $19,751 – $80,250 | $14,101 – $53,700 |
22% | $40,126 – $85,525 | $80,251 – $171,050 | $53,701 – $85,500 |
24% | $85,526 – $163,300 | $171,051 – $326,600 | $85,501 – $163,300 |
32% | $163,301 – $207,350 | $326,601 – $414,700 | $163,301 – $207,350 |
35% | $207,351 – $518,400 | $414,701 – $622,050 | $207,351 – $518,40 |
37% | $518,401 + | $622,051 + | $518,401 |
The long-term capital gains tax rate on crypto would apply if you sold your crypto after holding it for more than a year, and these gains would be taxed separately from your regular income. Currently, these are taxed at 0%, 15%, or 20%, depending on your income and filing status. The long-term capital gains rate is lower than the short-term capital gains rate, therefore holding your crypto assets for more than a year is considered a tax benefit.
2020 Long- Term Capital Gains Tax Rates | |||
Tax Rate | Income – Single | Income – Married Filing Jointly | Income – Head of Household |
0% | $0 – $40,000 | $0 – $80,000 | $0 – $53,600 |
15% | $40,001 – $441,450 | $80,001 – $496,600 | $53,601 – $469,050 |
20% | $441,451 + | $496,601 + | $469,051 + |
Only individuals with annual incomes over $1 million would be subject to President Biden’s proposal to boost the long-term capital gains tax from 20% to 39.6%. Brian Dees, a White House official, estimates that this would affect only 0.3 percent of households.
Because of this, most cryptocurrency traders and investors will not experience any change in their long-term tax rates. ‘Those who would see their tax burden nearly double will have less incentive to save for the long run.
Capital gains tax increases in the Tax Reform Act of 1986 and in the American Taxpayer Relief Act of 2012 also sparked a rise in stock sales. This pattern suggests that crypto whales holding big sums of unrealized gains may make large sales in order to lock in a reduced tax rate on their gains. There is still a lot of uncertainty surrounding the proposal, but there are ways to offset capital gains and thereby minimize cryptocurrency gains taxes in the event that rates rise.
When tax season comes around, no one enjoys discovering that they owe money. Smart crypto investors are well aware of the tax ramifications of their trades year-round, and they take advantage of this through a practice known as tax-loss harvesting. In order to minimize your capital gains taxes, you can sell your bitcoin assets while they are depreciating to take advantage of tax-loss harvesting. You may be able to benefit from tax-loss harvesting even if you don’t have capital gains to offset.
Assume that throughout the course of the year, you’ve sold some coins for a profit and currently have $10,000 in capital gains in the bank. However, you’re also sitting on $5,000 worth of cryptocurrency that’s lost value. By selling your crypto for less than you paid for it, you can take advantage of the tax-loss harvesting approach.
To put it another way, this loss would reduce your capital gains tax liability by $5,000. Tax-loss harvesting would become even more critical for cryptocurrency traders if the proposed increase in capital gains tax is implemented.
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Dave Miller is an IT Consultant for Online Cloud Security and has over 7 years of experience in the Information Technology space. He also specializes in repairing laptops & computers. In his spare time, he loves to talk about new technologies and hosts monthly IT and Cyber Security meetings in the Houston area.
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