With the constant increase in the cryptocurrency market, the Internal Revenue Service (IRS) and the whole world are following this record-breaking change. For people who own cryptocurrencies such as Bitcoin, Ethereum, Litecoin, and a lot more, there is a need to have an understanding of how it impacts your tax liability each and every time you purchase, sell, or invest in cryptocurrencies. There are various ways in which one can owe taxes on cryptocurrency. Another situation that may require you to be tasked is when you trade one crypto for another. And in cases where you do not have an accurate and detailed record of your transactions, it can be quite challenging to put together your losses and profits at tax time. And if you end up not paying your cryptocurrency taxes, you might eventually suffer deeply for it. In this article, you will be able to get an in-depth knowledge of how cryptocurrencies are taxed.
Now, let’s take a look at what we mean by cryptocurrency. A cryptocurrency is considered to be a decentralized digital store of value that serves as a medium of exchange, as it is reliant on the blockchain technology to record and verify all transactions. In the year 2009, the first cryptocurrency (Bitcoin) was launched. And as of today, there are various other cryptocurrencies circulating around the world now.
How Cryptocurrencies Are Taxed If Used For Purchases And Mining
In 2014, the Internal Revenue Service (IRS) made a ruling that cryptocurrency should be considered a capital asset such as bonds or stock instead of being treated as a fiat currency such as USD or EUR. As a result of this, it has been taxed the same way other capital assets are taxed on their capital gain. When you sell more capital assets like stocks, you tend to owe taxes when you sell at a profit, and if you incur losses, you do not owe taxes. The same applies to cryptocurrencies. When you buy goods or services using cryptocurrency, and the total amount of cryptocurrency spent has increased in value over what you made payment for, your spending has therefore incurred capital gains taxes. If you seem to have challenges in solving any of your tasks, it is advisable to hire a tax professional, as they are experts who are quite knowledgeable in the field.
Also, if you are able to accumulate cryptocurrency by mining, or if you get it as a payment for goods or services, it is seen as a regular taxable income. With this, you owe tax on the total fiat market value of the cryptocurrency upon receiving it. In situations where you decide to hold the particular crypto you earned from mining or any other activity, when its original value increases or you sell it at a certain profit, you tend to owe capital gain taxes on the profit gained, and this is dependent on how long you hold it.
When Am I Expected To Pay Tax On Cryptocurrency?
Basically, holding a crypto asset has absolutely no tax implications. However, there are certain other actions that do, and these include:
- Selling of cryptocurrency
- Trading or swapping one type of cryptocurrency for another
- The purchase of goods and services using cryptocurrency
- Conversion of crypto to government-issued currency.
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How Is The Crypto Tax Rate Calculated?
When it comes to taxing cryptocurrencies, they can be considered either short-term capital gains or long-term capital gains. In cases where you decide to sell or trade your crypto, your capital gains tax is calculated based on two factors, which are: the profit or loss realized from it and the period of time in which you held it before deciding to sell or trade it. The period of holding your crypto starts the next day after making a cryptocurrency transaction and ends the day you sell or trade it.
If your crypto asset has a holding period of between 1 and 365 days, it will be taxed as ordinary income and considered short-term capital gains tax. Short-term gains are subjected to the same tax rate as ordinary income, including wages, commissions, salaries, and others. When based on the ordinary income tax rate, there is a 10% to 37% variation in tax rates. If your crypto asset has a holding period of more than 366 days, then it is considered a long-term capital gains tax. However, there is a 0 to 20% variation in the tax rates, and this is based on the ordinary income tax rate.
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How To File Your Crypto Taxes
As one that engages in crypto transactions, it is necessary to get organized with your cryptocurrency taxes. Therefore, here are things you need to keep in mind:
- Keep Accurate Record Of Every Transactions
It is essential to keep proper and accurate track of all transactions related to your cryptocurrencies, which includes the period of time you used in holding, how much you sold, the receipt for each and every transaction, as well as how much you paid for your cryptocurrencies. There are various tools available for tracking your cryptocurrency transactions, as they connect to exchanges and crypto wallets and also help fill out the form required to file your crypto taxes. Some of these tools include CoinTracker and Koinly.
- Completely Fill Out The Proper Tax Forms
There are certain forms to be filled out, and this is dependent on how you make use of your cryptocurrencies.
- Schedule D: it summarizes the entire capital losses and profit made from all investment, and this also includes cryptocurrencies.
- Schedule C: coins received based on mining need to be disclosed whether they were received as a hobby or as a business.
- Schedule 1: reporting your crypto mining activity as a hobby. There will be no need to owe self-employment tax, but there will be a limit on what can be deducted as an expense.
- Form 8949: it summarizes every purchase of cryptocurrency as an investment, as it includes the date and price of the transaction, the total number of coins, the date and price at which you sold the cryptocurrency, as well as your profit or loss for those transactions.
- File Your Taxes
In cases where you make use of tracking tools such as CoinTracker and Koinly, you can decide to connect them with any online tax software you prefer. After that, you can then make use of the online tax software to fill out your entire state and federal tax returns.
- Hire a Professional
Complications might arise when preparing for cryptocurrency taxes, as constant changes affect the laws that surround them. You can transfer cryptocurrencies between exchanges or wallets and buy them using USD without necessarily creating a taxable situation. However, for those who have made quite a huge amount of money from cryptocurrency or need to catch up on previous transactions, it is advisable to hire a certified public accountant (CPA) who has in-depth knowledge concerning tax work, in order to avoid being chased around by the Internal Revenue Service.
In conclusion, one good thing about crypto tases is the fact that you only owe taxes when you realize a profit from selling or spending your crypto asset. However, if you incur a loss, there will be no taxes owed on your transactions.