At a Glance
The IRS estimates it loses over $50 billion annually in unreported cryptocurrency tax transactions, equating to $1.5 billion in lost tax revenues, prompting regulators to scrutinize cryptocurrency (crypto) transactions more closely. Beginning with the tax year 2021, the individual tax Form 1040 was updated with a digital assets section requiring individuals to specify whether they received or sold digital assets, including cryptocurrencies and other virtual assets.
Laws regulating crypto possession, transfer, and taxation are continually being updated and debated by Congress. Familiarizing yourself with crypto tax rules will help you understand which digital asset transactions are taxable and how to stay compliant, whether filing as a business or individual.
Crypto Classification Under the IRS
In 2014, the Internal Revenue Service (IRS) released Notice 2014-21, its first guidance notice on cryptocurrencies following the first surge in Bitcoin prices in late 2013. The agency stated it would start taxing the sale of crypto as property sales, subjecting it to capital gains taxes. In 2022, the agency defined and started using the term ‘digital asset’ in official documentation and tax forms.
The IRS defines a digital asset as any digital representation of value recorded on the blockchain or similar technologies. In simpler terms, digital assets are money or collectibles that exist entirely online on specially designed virtual, decentralized ledgers.
The most common types of digital assets are:
- Convertible virtual currencies (CVCs): Currency commonly referred to as cryptocurrency, such as Bitcoin (BTC) or Ethereum (ETH), are CVCs. It also includes non-cryptographic virtual currency that can be readily converted to U.S. Dollars, such as the Linden Dollars (L$) used in the online virtual world of Second Life.
- Stablecoins: A stablecoin is a specific type of cryptocurrency whose value is connected (or “pegged”) to a fiat currency or another commodity. One of the most common stablecoins in the United States is Tether (USDT), which is pegged to the value of the U.S. Dollar. Others include Pax Gold (PAXG) and SilverTokens (SLVT), which are tied to the values of gold and silver, respectively.
- Non-fungible tokens (NFTs): An NFT is digital proof of ownership or certificate of authenticity recorded in a cryptographic ledger. It typically represents or is associated with pieces of digital art. It is valued using cryptocurrency and can be bought and sold. NFTs can also be encrypted to a blockchain like Ethereum, which functions as a digital contract ledger and a currency.
What Crypto Transactions Are Taxable?
Many types of crypto transactions are now subject to taxation under United States law. Taxed crypto transactions include:
- Selling digital assets for cash: If you or your organization sells CVCs, stablecoins, or NFTs, it can result in capital gains or losses on the sale. If you realize a capital gain, you may owe capital gains taxes.
- Trading digital assets for other digital assets: Typical examples include converting one type of cryptocurrency for another, using cryptocurrency to purchase an NFT, or selling an NFT for crypto. In all cases, disposing of the first asset to acquire another can lead to capital gains or losses, exposing you to capital gains taxes.
- Completing a payment in cryptocurrency: When you use cryptocurrency to make payments, it is the same as selling or disposing of that cryptocurrency. This transaction might result in a capital gain or loss, depending on the acquisition cost and the cryptocurrency’s value at the time of the transaction, and could be subject to capital gains taxes.
- Mining cryptocurrency: In crypto jargon, mining uses powerful computers to solve complex equations or puzzles on the blockchain. Successfully solving an equation on the blockchain can reward the miner with a newly minted quantity of cryptocurrency. Receiving crypto from mining is treated the same as receiving ordinary income. For instance, if you successfully mine one crypto coin worth $8,600 at the time of mining, the law treats it as receiving $8,600 in income.
- Staking cryptocurrency: Earning crypto through staking is considered taxable income. In a staking model, participants lock up a portion of their cryptocurrency to support the network and facilitate the creation of new blockchain blocks. The more you stake, the higher your chances of forging a new block and being rewarded with additional crypto. This earned amount is subject to taxation.
- Receiving an airdrop: In the crypto world, an “airdrop” is an event where cryptocurrency is distributed to individuals and other entities for free. If you receive crypto in an airdrop or a similar event, it is treated as income and subject to income taxes.
- Receiving a payment in crypto: If your organization receives a payment in cryptocurrency from another entity, such as a client or a customer, you may be subject to income taxes.
- Earning yield or interest in crypto: Some organizations and decentralized finance (DeFi) platforms allow users to hold cryptocurrency and earn yield or interest. This practice is the crypto equivalent of earning interest on a bank account and can be done by staking, lending, or participating in other activities.
Earning yield or interest via crypto holdings is treated as interest income, subjecting it to appropriate interest income taxes
Types of Crypto Transactions That May Not Be Subject to Taxes
While many types of crypto transactions are subject to taxation, some are not. Understanding which transactions are not taxed is essential for accurately calculating your tax liability.
- Buying digital assets: Using fiat currency to purchase cryptocurrency is not taxed, similar to buying property or other assets.
- Transferring digital assets between your wallets: A crypto wallet is software designed to hold cryptocurrency. You can freely transfer crypto between wallets you control without being subject to taxation because you have not transferred it to another person or entity.
- Gifting digital assets: Technically, gifts of cryptocurrency and NFTs are not subject to tax as long as the fair market value of the gifted item does not exceed the annual gift exclusion threshold. If it does, you may be subject to a gift tax, which must be reported on an IRS Form 709. As of 2023, the annual exclusion is $17,000.
- Donating digital assets: Donating crypto, NFTs, and other digital assets is typically not subject to taxation. The transaction may qualify as a charitable contribution if the donation recipient is a tax-exempt, nonprofit group or organization under IRC section 501(c)(3). This type of transaction is eligible for a tax deduction.
Important Tax Forms From Cryptocurrency Exchanges
Cryptocurrency exchanges are platforms where individuals and companies can buy, sell, and trade crypto. Exchanges are required to issue specific IRS tax forms when interacting with users, beginning with the tax year 2023.
The primary purpose of IRS Form 1099-MISC is to report income from miscellaneous sources, such as prizes, awards, rents, insurance proceeds, and many other types of income payments.
You may be issued a Form 1099-MISC from crypto exchanges for various taxable cryptocurrency transactions, NFT transactions, and other changes in the value of digital assets. Examples include:
- Receiving crypto earnings
- Receiving crypto income from mining or staking
- Generating yield
- Receiving an airdrop
- Obtaining new tokens after a hard fork
If your combined crypto earnings reach or exceed $600 this year, cryptocurrency exchanges must provide the corresponding Forms 1099-MISC. You can then use the forms to report your crypto earnings.
The IRS Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, is a variant of IRS Form 1099. Its primary purpose is to report proceeds from the sale or trade of stocks, bonds, and other investment assets.
You may need Form 1099-B to report the sale or trade of digital assets, including CVCs and NFTs, for capital gains purposes. For example, if your organization purchased an NFT for $24,000 and sold it to a client for $40,000, you will need Form 1099-B to report the $16,000 in capital gains.
As with Form 1099-MISC, digital asset brokers and crypto exchanges must provide Form 1099-B after completing a transaction.
IRS Form 1099-DA is a future tax form proposed by the IRS and the Department of the Treasury in an August 2023 announcement.
Under the proposal outlined by the two agencies, Form 1099-DA would become a new version of IRS Form 1099 specifically aimed at reporting sales and exchanges of digital assets. Its purpose is to reduce confusion on the types of tax forms to use when dealing with crypto exchanges and reporting crypto income with capital gains.
If adopted, sales and exchanges of digital assets taking place on or after January 1, 2025, must be reported on the new form. Additionally, brokers and exchanges will be required to start issuing this new form to users.
Capital Gains and Cryptocurrency
Capital gains are profits realized from selling or trading capital assets. Capital assets traditionally refer to property like stocks, bonds, real estate, collectible art pieces, vehicles, or precious metals.
Today, the IRS considers all digital assets, including cryptocurrency and NFTs, as capital assets. Consequently, if you profit from the trade or sale of these assets, you are realizing capital gains.
All capital gains are subject to taxation in the United States. In other words, selling and trading crypto affects your tax liability, like selling real estate or trading gold. If you exchange cryptocurrency for more than you initially paid, it will create a capital gain during the year.
Cryptocurrency Tax Rates
The tax rates for selling or trading crypto assets are the same as other capital asset gains. Under IRS Topic 409, the applicable tax rates primarily depend on whether your capital gains are short-term or long-term.
- Short-term capital gains: Gains on the sale or exchange of crypto assets are considered short-term capital gains if you previously held the assets for a year or less.
- Long-term capital gains: If you hold a crypto asset for more than a year before selling or exchanging it for a profit, the gains realized are considered long-term.
If you realize capital gains on the sale or trade of non-fungible tokens (NFTs), your gains may be defined as net capital gains from selling collectibles. IRC Section 408(m) collectibles typically refer to traditional, tangible collectibles, such as works of art, stamps, or coins. They are subject to a unique tax rate of 28%.
Determining Crypto Gains or Losses for Your Taxes
Accurately determining gains and losses associated with crypto transactions is essential for accurate tax reporting. Keep records of all crypto transactions and follow these steps:
Identify and record transaction types. Log all purchases, sales, and trades of crypto assets for each year, including dates. Your transaction logs should include instances where you or your organization purchased other goods and services with crypto.
Calculate the cost basis and fair market value. When purchasing a crypto asset, the U.S. dollar amount or equivalent becomes that asset’s cost basis. When selling a crypto asset, determine its fair market value (FMV) on the date of sale.
Provide this information to your tax preparer in addition to the Form 1099-B received from the exchange you are using to facilitate crypto transactions.
Using Form 8949 for Crypto Capital Gains
IRS Form 8949 allows you to report capital gains and losses, including digital assets. This tax form is essential for accurate tax reporting when dealing with crypto assets.
When you or your organization obtains or disposes of crypto assets, use this form to:
- Detail the type and quantity of assets acquired
- Record the dates of acquisition
- Record the dates of sale or disposal
- Specify each asset’s cost basis
- Record all capital gains and losses realized
How Windes Can Help
At Windes, our tax preparation professionals can help you complete the necessary forms for reporting crypto assets. We will help you understand your responsibilities for reporting income or capital gains so you meet the IRS requirements under new crypto taxation guidelines.
We can help you navigate the complexities of owning cryptocurrency and its tax implications. We will ensure you remain compliant with the latest tax laws through expert tax services and knowledgeable cryptocurrency guidance while minimizing your tax liabilities.
Contact us today for guidance on cryptocurrency taxation, helping you safeguard your assets and investments.