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Crypto Taxes
Crypto Taxes

The Ultimate Crypto Tax Guide (2021)

Taxes aren’t the first thing most investors consider when jumping into the world of Bitcoin and cryptocurrencies. However, as the IRS continues to crack down on crypto tax compliance, it’s becoming increasingly important to learn about how cryptocurrencies are taxed. 

In this guide, we discuss everything you need to know about cryptocurrency taxes. From the high level tax implications to the actual tax forms you need to fill out, you’ll learn all about what you need to stay compliant and get your taxes done properly.

This guide was created by the tax team at CryptoTrader.Tax, the #1 crypto tax software. Today, over 100,000 crypto investors use CryptoTrader.Tax to finish their crypto taxes in minutes. You can create a free account here

This guide breaks down the specific crypto tax implications within the U.S. You can see other country-specific tax guides here

The basics of crypto taxes

In the U.S., cryptocurrencies like Bitcoin are treated as property for tax purposes. 

Just like other forms of property like stocks, bonds, and real-estate, you incur capital gains and capital losses on your cryptocurrency investments when you sell, trade, or otherwise dispose of your crypto.

Bitcoin capital gains example

Depending on what tax bracket you fall under, you will pay a certain percentage of tax on this capital gain. Tax rates fluctuate based on your personal tax bracket and whether the gain was short term or long term (more on this later).

Outside of buying, selling, and trading, if you earn cryptocurrencies—whether through a job, mining, staking, airdrop, or interest from lending activities—you are liable for income taxes on the US Dollar value of your crypto earnings. 

We will walk through examples for all of these scenarios in more detail below.

When do you owe taxes on your crypto?

Whenever you incur a taxable event from your crypto investing activity, you incur a tax reporting requirement.

A taxable event simply refers to a scenario in which you trigger or realize income. As seen in the IRS virtual currency guidance, the following are all considered taxable events for cryptocurrency:

  1. Trading crypto to fiat currency like the US dollar
  2. Trading one crypto for another cryptocurrency
  3. Spending crypto to purchase goods or services
  4. Earning crypto as income

Below, we run through practical examples to illustrate each of these taxable events.

1. Do you pay tax when you trade crypto for fiat?

Selling crypto for fiat currency is a taxable event.

Crypto losses taxes

In this example, Emma incurs a $200 capital loss (1,000 - 1,200). This loss gets deducted and actually reduces Emma’s taxable income. 

2. Do you pay tax when you trade cryptocurrency for other cryptocurrencies?

Trading one crypto for another is treated as a disposal.

Crypto to crypto trade taxes

In this scenario, John incurs a taxable event by trading his Litecoin for Ethereum. Trading one crypto for another is treated as a disposal, and here John incurs a $150 capital gain from the trade which he would need to report on his taxes (400 - 250).

3. Do you pay tax when you buy goods and services with crypto?

Buying goods and services with crypto is considered a taxable event.

Do you pay taxes when you spend your crypto?

In this example, Taylor incurs a taxable event when she disposes of her bitcoin.

4. Do you pay taxes when you earn crypto income?

Yes, earning crypto income is considered personal income subject to income tax.

Earning crypto taxes

Common forms of crypto income include earning crypto staking rewards, crypto interest, and crypto referral rewards.

When don’t you owe taxes on your crypto?

In certain circumstances, you will not trigger any taxable events when transacting with crypto, and you will not have to pay or report any cryptocurrency taxes.

You do not trigger a taxable event when you:

  1. Buy and hold crypto
  2. Transfer crypto from one wallet you own to another wallet you own

1. Do you pay taxes for holding cryptocurrency?

If you simply buy Bitcoin or another cryptocurrency and hold it in a wallet, you do not have any sort of tax reporting requirement as you haven’t realized a gain or loss on your investment yet.

Once you sell, trade, or trigger a taxable event by disposing of the coin, this is when you realize a capital gain or loss.

2. Do you pay taxes for wallet to wallet transfers?

Sending one cryptocurrency from one wallet you own to another wallet you own is not a disposal of your crypto. You still own the crypto, and thus you do not trigger a taxable event.

How do you calculate your crypto taxes?

To calculate your capital gains and losses from each of your crypto sells, trades, or disposals, you simply apply the formula:

Fair Market Value - Cost Basis = Capital Gain/Loss

What is fair market value?

Fair Market Value is simply the price an asset would sell for on the open market. In the case of cryptocurrency, this is typically the sale price in USD terms.

What is cost basis

Cost Basis represents how much money you put into purchasing your property (i.e. how much it cost you). Cost basis includes purchase price plus all other costs associated with purchasing your cryptocurrency (fees, etc).

From our examples above, it’s easy to see this formula in action. If you buy 1 Litecoin for $250, your cost basis is $250 per Litecoin. If you sell or trade it when it’s worth $400, that $400 is the fair market value. Applying the formula:

$400 (Fair Market Value) - $250 (Cost Basis) = $150 Gain

Fairly straightforward.

Now, let’s dive into a more complex example to see how you would calculate your gains and losses using this same formula when you have a number of transactions instead of just one or two.

How to calculate gains and losses

Say you have the following transaction history on Coinbase:

  • 1/1/21 - Buy 1 BTC for $29,000
  • 2/2/21 - Buy 1 BTC for $36,000
  • 3/3/21 - Buy 1 BTC for $50,000
  • 4/4/21 - Trade 0.5 BTC for 14.5 ETH (0.5 BTC was worth $29,000 at this time)
Crypto transaction history example

With this transaction history, you first trigger a taxable event (and thus a capital gain/loss) when you trade 0.5 BTC for 8 ETH. To calculate the gain/loss, you need to subtract your cost basis of 0.5 BTC from the fair market value at the time of the trade.

The question here is, what is your cost basis in the 0.5 BTC that you traded for 8 ETH? After all, you have purchased 3 different bitcoins all at different prices prior to this trade.

To answer this, you have to determine which bitcoin you are disposing of in this scenario. 

To determine the order in which you sell various cryptocurrencies, accountants use specific costing methods like First-In First-Out (FIFO) or Last-In First-Out (LIFO). The standard method is First-in First-out.

Understanding accounting methods

These costing methods work exactly how they sound. For First-In First-Out, the asset (or cryptocurrency) that you purchased first is the one that gets sold off first. So you are essentially disposing of your crypto in the same order that you first acquired them.

If we use First-In First Out for our example above, we “sell off” that first bitcoin which was acquired at $29,000 on 1/1/21. The cost basis in this first bitcoin is $29,000, making the cost basis for 0.5 of this BTC $14,500 (0.5 * $29,000).

As denoted in the example, the fair market value at the time of 0.5 BTC at the time of trading was $29,000.

So by applying the formula, we can see that this transaction history triggers a $14,500 capital gain (29,000 - 14,500). This gain gets reported on your taxes and increases your taxable income. 

You can learn more about how various costing methods work to calculate your gains and loss for your crypto trades in this blog post: FIFO, LIFO, and HIFO for crypto trading.

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The challenge for crypto traders

As you can see from the examples above, calculating your capital gains and losses from your crypto trading activity requires records to keep track of your cost basis, fair market value, and USD gain or loss every time you dispose of a crypto (trade, sell, spend etc).

Without this information, you aren’t able to calculate your realized income from your trading activity, and you aren’t able to report it on your taxes.

This is extremely challenging for many cryptocurrency investors as most haven’t been keeping detailed records of their investing activity. Trying to track the cost basis and USD prices for all of their cryptos across all of their exchanges, wallets, and protocols at any given time quickly turns into a difficult, if not impossible, spreadsheet exercise. 

This is the reason why hundreds of thousands of crypto traders are turning to crypto tax software like CryptoTrader.Tax to automate all of their crypto tax reporting. You can sign up for a free account here.

Reporting your crypto and bitcoin on your taxes

How do you report crypto on your taxes?

If you’re like most cryptocurrency investors, you likely have only bought, sold, and traded crypto (i.e. capital gains investing activity) via a cryptocurrency exchange. This crypto income is considered capital gains income and is reported as such. 

On the other hand, if you earned cryptocurrency—whether that's from a job, mining, staking or earning interest rewards—that earned income is generally treated as ordinary income and is reported as such.

We dive into the reporting for each of these income types below.

Reporting crypto capital gains and losses

Your capital gains and losses from your crypto trades get reported on IRS Form 8949.

Form 8949 is the tax form that is used to report the sales and disposals of capital assets, including cryptocurrency. Other capital assets include things like stocks and bonds. 

To fill out Form 8949, list all of your cryptocurrency trades, sells, and disposals onto Form 8949 (pictured below) along with the date you acquired the crypto, the date your crypto was sold or traded, your proceeds (Fair Market Value), your cost basis, and your gain or loss for the trade. 

IRS Form 8949 for crypto

Once you have each trade listed, total them up and fill in your net capital gain or loss for the year at the bottom. 

For a detailed walkthrough of filling out Form 8949, checkout this blog post: How To Report Cryptocurrency to the IRS with Form 8949.

Reporting crypto ordinary income 

Unfortunately, ordinary income doesn’t fall nicely onto one tax form like we saw with capital gains and Form 8949. 

The ordinary income you receive from mining, staking, interest accounts, or perhaps crypto you received as payment from a job get reported on different tax forms, depending on the specific situation.

Schedule C - If you earned crypto as a business entity, like receiving payments for a job or running a cryptocurrency mining operation, this is often treated as self-employment income and is reported on Schedule C

Schedule B - If you earned staking income or interest rewards from lending out your crypto, this income is generally reported on Schedule B.

Schedule 1 - If you earned crypto from airdrops, forks, or other crypto wages and hobby income, this is generally reported on Schedule 1 as other income.

To make things easier for investors, CryptoTrader.Tax generates a complete income report that is included with your completed crypto tax reports. This report details the US Dollar value of all of your cryptocurrency income events that you received throughout the year: mining, staking, airdrops, and more. This income report can be used to complete your relevant ordinary income tax forms like Schedule 1, Schedule B, and Schedule C.

If you have any questions about how your crypto-related income needs to be reported, feel free to reach our live-chat customer support team via the chat widget on our homepage. We're happy to answer any of your questions!

For a step-by-step walkthrough of the crypto tax reporting process, checkout our explainer video below.

How much tax do you pay on your crypto?

Your personal income tax bracket and the holding period of your crypto assets (short term vs. long term) will determine how much tax (and what % of tax) you pay on your crypto income. This will be different for each investor.

Short-term capital gains tax events

Short-term capital gains apply for any crypto that was held for less than 12 months. 

Short term capital gains tax

Short term capital gains don’t get any special tax treatment. They are simply treated as income on your taxes (just like income from your job), and thus you pay taxes on your short term capital gains according to your personal income tax bracket (outlined further below).

Long-term capital gains tax events

Long-term capital gains apply for any crypto that was held for 12 months or more.

The government wants to incentivize investors to invest for the long term, so they offer tax incentives for doing so. 

Long-term capital gains tax rates offer lower taxes than short term gains, and the chart below depicts these rates.

Long term capital gains tax brackets

As you can see, holding onto your crypto for more than one year can provide serious tax benefits. If you are in the highest income tax bracket, your taxes on your long term capital gains will be 20% instead of 37% (the highest tax rate for short term gains).

You can use CryptoTrader.Tax to automatically detect which cryptocurrencies in your portfolio qualify for long-term capital gains and to help plan for future trades. This can help save you tens of thousands of dollars in taxes in the long-run. Get started for free here

Crypto income tax events

Crypto transactions that are classified as income are generally taxed at your personal income tax bracket.

This includes your short-term capital gains (as mentioned above), staking rewards, airdrops, and interest earnings. 

These income tax brackets are outlined in the chart below.

Short term capital gains tax brackets

How is crypto income taxed?

Let’s say you made $25,000 in short-term capital gains from your crypto trading, and this was the only income you had for the year. Would you simply pay 12% of tax on that $25,000?

No. Instead of paying a flat tax on your entire income, you’ll pay different tax rates on each individual portion. In this case, you actually pay 10% on the first $9,875 and 12% on the next $15,125.

Taxable income brackets

How do DeFi taxes work? 

Recently, cryptocurrency lending platforms and other DeFi services like Uniswap, Maker, and Compound have exploded in popularity.

Receiving interest income from crypto lending activities or liquidity pools is considered a form of taxable income and must be reported on your taxes—similar to mining and staking rewards. 

The full tax implications associated with transactions common to the DeFi landscape are outside of the scope of this piece; however, we discuss them thoroughly in our Defi Crypto Tax Guide.

How do NFT taxes work?

Non-fungible tokens, or NFTs, have exploded in popularity amongst crypto native audiences and beyond.

From a tax perspective, NFTs are treated as property, similar to other cryptocurrencies. When you buy an NFT and later sell it, you incur a capital gain or loss that gets reported on IRS Form 8949.

NFT capital gains taxes

For more information, check out our Complete NFT Tax Guide.

Why crypto exchanges can't provide accurate tax forms

This is where a big problem exists within the crypto tax space. 

Cryptocurrency exchanges like Coinbase, Binance, and others do not have the ability to provide their users with accurate capital gains and losses tax reports. This is not a fault of the cryptocurrency exchange itself, it is simply a product of the unique characteristics of cryptocurrencies—namely their transferability.

Because users are constantly transferring crypto into and out of exchanges, the exchange has no way of knowing how, when, where, or at what cost basis you originally acquired your cryptocurrencies. The exchange only sees when crypto appears in your wallet. 

The second you transfer crypto into or out of an exchange, that exchange loses the ability to give you an accurate report detailing the cost basis and fair market value of your cryptocurrencies, both of which are mandatory components for tax reporting.

Bitcoin taxes example

As you can see pictured below, Coinbase themselves explains to their users how their generated tax reports won’t be accurate if any of the below scenarios took place. This affects over two thirds of Coinbase users, which amounts to millions of people. 

You can read more about the “crypto tax problem” in our blog post: Why Exchanges Can’t Report Crypto Taxes.

Coinbase tax reporting

The crypto tax reporting solution

The solution to the crypto tax problem hinges on aggregating all of your cryptocurrency data that makes up your buys, sells, trades, airdrops, forks, mined coins, exchanges, swaps, and received cryptocurrencies into one platform so that you can build out an accurate tax profile containing all of your transaction data.

Once all of your transactions (buys, sells, trades, earnings) are in one spot, you’ll be able to calculate cost basis, fair market values, gains/losses, and income for all of your investing activity.

You can aggregate all of your transaction history by hand by pulling together your transactions from each of your exchanges and wallets. Or you can avoid the manual work and automate this process with the use of crypto tax software.

Cryptocurrency tax software

Crypto tax software

Cryptocurrency tax software like CryptoTrader.Tax was built to automate the entire crypto tax reporting process. 

By integrating directly with leading exchanges, wallets, blockchains, and DeFi protocols, the CryptoTrader.Tax engine is able to auto-generate all of your necessary tax reports based on your historical data. You can test out how it works by creating an account for free.

How it works

1. Select each of the cryptocurrency exchanges, wallets, and platforms you’ve used throughout the years.

2. Import your historical transactions by connecting your accounts via API or uploading the CSV transaction history report exported by your exchanges.


3. Finally, generate your tax reports based on this imported data with the click of a button.

Once you’ve generated your tax reports, you can send them to your tax professional or import them directly into your preferred tax filing software like TurboTax or TaxAct.

You can test out the software yourself by creating a free account here.

To make crypto tax reporting as easy as possible, the CryptoTrader.Tax team has partnered with TurboTax. This allows your tax reports to be imported directly into your TurboTax account.

IRS crypto

How does the IRS know about your crypto?

The IRS uses a variety of tactics to detect cryptocurrency investments and unreported income. The most predominant of which is the 1099 reporting system.

Major exchanges like Coinbase, Gemini, Uphold, Kraken, and others report certain customer activity to the IRS using form 1099-K and/or other related 1099’s. These 1099’s all serve the same general purpose: to report non-employment related income to the IRS. 

Both you and the IRS get sent a copy of these forms at year-end. 

If the IRS receives a 1099 from your crypto exchange but sees no cryptocurrency income reported on your taxes, your account will be flagged and an automated CP2000 letter will be sent alerting you of your non-reported income and tax liability. 

You can learn more about how 1099-K works for your crypto exchange activity here

Outside of 1099 reporting, the IRS works with blockchain analytics companies like Chainalysis to track cryptocurrency movements directly on-chain. Since 2015, the IRS has spent more than 10 million dollars on Chainalysis contracts. This data is used to identify tax fraud and money laundering.

What happens if you don’t report your crypto taxes?

Intentionally not reporting your cryptocurrency gains, losses, and income on your taxes is considered tax fraud by the IRS. 

The IRS can enforce a number of penalties for tax fraud, including criminal prosecution, five years in prison, along with a fine of up to $250,000.

Over the past two years, the IRS has aggressively been cracking down on cryptocurrency tax compliance. The agency has sent tens of thousands of warning and action letters to Coinbase users suspected of inaccurate tax reporting. It has also updated the main US income tax form (1040) to include a question that every US taxpayer must answer under penalty of perjury:

“At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

With this much scrutiny on the cryptocurrency asset class, it’s likely that we will see audits and criminal tax prosecutions continue to increase as cryptocurrency and bitcoin adoption accelerates.

How do other countries handle crypto taxes?

Similar to the U.S., countries all over the world have started taking action and enforcing cryptocurrency-related income taxes. While the tax rules are very similar to the U.S., small differences do exist. For more detailed information, check out our guides on various countries below:

How do you lower your crypto taxes?

As with any other form of income, there are certain steps and actions you can take to actively minimize your cryptocurrency-related tax obligations. We discuss some of these strategies below.

Tax-loss harvesting

Tax-loss harvesting is the practice of selling a capital asset at a loss to offset a capital gains tax liability. It provides one of the best opportunities for investors to reduce their cryptocurrency gains for the year. 

Let’s explore an example of tax loss harvesting. 

Cryptocurrency tax loss harvesting

In this example, Amy reduces her tax liability for the year by claiming her capital losses. 

You can use the CryptoTrader.Tax Tax-Loss Harvesting Dashboard to automatically detect which assets in your crypto portfolio are “underwater’.

Learn more about how you can tax loss harvest with cryptocurrency here

Long-term capital gains vs. short-term capital gains

For any significant cryptocurrency gains that you plan to realize, you should see if you have the ability to lock in long term capital gains rates. 

Remember, long-term capital gains apply for crypto that is held for longer than 1 year, and they offer significantly lower tax rates when compared to short-term gains.

Long-erm vs. short-term capital gains taxes

Prior to selling or trading, you should review your portfolio to see which assets qualify for long term gains and which do not. This is a great strategy to help lower your cryptocurrency tax bill for the year.

What if you forgot to report your crypto taxes?

If you’re like many other crypto investors, there’s a strong chance that you weren’t always aware of the fact that your crypto-related income needed to be reported on your taxes. 

If you are in this situation, don’t stress out. You can amend a prior year's tax return to include your crypto-related income with IRS Form 1040X.

Many cryptocurrency investors go through this process without issue, and it’s always better to amend your return in good faith rather than waiting for the IRS to find you.

For a detailed guide, check out our blog post on how to amend your tax return to include your crypto.

Other cryptocurrency transactions and tax examples

How are airdrops taxed?

Cryptocurrency received from an airdrop is taxed as income. This means that you are liable for income taxes on the USD value of the claimed airdrop. If you sell, trade, or otherwise dispose of your airdropped tokens in the future, you will incur capital gains or losses depending on how the price of your tokens has fluctuated.

The IRS is clear in its guidance regarding the income treatment of airdrops.

Airdropped cryptocurrency tax example

How are hard forks taxed?

If a certain cryptocurrency that you are holding goes through a hard fork which “occurs when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger,” the new forked cryptocurrency you receive is taxed as income. 

Your cost basis in the newly received cryptocurrency becomes the income you recognize.

Hard fork crypto taxes

How is crypto interest taxed?

Currently, platforms like Gemini and BlockFi offer users interest rewards for holding select cryptocurrencies. Meanwhile, DeFi protocols like Compound offer users rewards for staking crypto. 

Cryptocurrency interest and crypto staking rewards are both considered personal income and are taxed accordingly.

Crypto interest income taxes

How is margin trading taxed?

Cryptocurrency exchanges like BitMex have popularized the use of margin trading. The IRS has not yet set forth explicit guidance on how cryptocurrency margin transactions should be handled from a tax perspective, but we can infer the likely treatment based on other guidance.

A margin trade consists of borrowing funds from an exchange to carry out a trade and repaying the loan afterwards. The conservative approach is to treat the borrowed funds as your own investment and pay capital gains tax on the margin trading profit and loss.

How are crypto gifts taxed?

If you are feeling generous, you can send a cryptocurrency gift to a friend or family member. Generally, cryptocurrency gifts are tax-free.

If you send a gift with a fair market value above $15,000, you will need to file a gift tax return. Remember, this form is for informational purposes and does not mean you will be required to pay taxes on your gift. 

For more information, check out our guide to crypto gift taxes.

How are crypto donations taxed?

Donating your crypto is tax free and deductible as long as you are donating to a registered charity.

If you are claiming a deduction larger than $500, you will need to report this on Form 8283.

The amount of your donation that is tax deductible depends on how long you have held the assets:

  • For crypto held for more than 1 year, you can deduct the cryptocurrency’s fair market value
  • For crypto held for less than a year, you can deduct whichever is lower: the cryptocurrency’s fair market value or your cost basis

Conclusion

The entire cryptocurrency ecosystem is still in its infancy. As the industry evolves, further rules and regulation will inevitably move forward. 

Our team tracks every update within the world of cryptocurrency regulation, and we will continue to update this blog post with the most pertinent information as it is released. You can also follow us on Twitter for real time updates and tax savings strategies.

“Our mission is to make cryptocurrency more accessible for everyone. If we can make tax reporting seamless, the entire ecosystem will benefit.” 

- David Kemmerer, Co-Founder & CEO, CryptoTrader.Tax

Questions?

If you have any questions about cryptocurrency taxes or your specific situation, feel free to reach out to our live-chat customer support team from the chat widget on our homepage. We have been doing this for a long time and are happy to answer any questions you have!

Recently updated on
November 15, 2021
Category:
Crypto Taxes

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