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Cryptocurrency has been around for some time. It gained a lot of traction over the last decade with the emergence of Bitcoin in the public eye. And several new types of cryptocurrencies have only fueled the urge to invest. But investors aren’t the only people who noticed. The IRS has noticed, too, prompting many to ask, “Do I pay taxes on crypto?”
The short answer is yes, you do pay taxes on crypto. But it isn’t so easy to determine when you pay those taxes, or how much. You’ll want to know the details if you are a current investor or plan on investing.
If crypto isn’t actually real money, why do I pay taxes on crypto? The short answer is because the IRS considers cryptocurrencies a property. And, as with many properties, if you sell, exchange, or use it to purchase other goods and services, you need to report it when you do your taxes. Essentially, you are paying a capital gains tax on your cryptocurrency earnings. But there’s a bit more to it than that.
How each of these events is taxed can also depend on how the crypto is used. Regardless, all crypto transactions will usually need to be reported. And, one of the only exceptions to the taxable crypto events is if you receive crypto as a gift.
You can also give crypto away as a charitable donation and claim it as such on your tax return.
Many crypto traders and those who currently own cryptocurrency are unaware of the current tax laws. Unfortunately, being unaware of the laws doesn’t excuse you from paying taxes on crypto. In fact, quite a few individuals have gotten into trouble for violating the tax laws, even though it wasn’t intentional.
In recent years, the IRS has made more of an effort to alert virtual currency holders of the tax rules. The campaign is called Virtual Currency Compliance, and thousands of traders received letters informing them that they needed to report their earnings. Additionally, federal annual tax return form 1040 requires you to indicate whether you’ve received, sold, sent, exchanged, or otherwise acquired a virtual currency.
There are additional forms for reporting your gains on selling cryptocurrency, which is what you’ll actually pay taxes on. However, there is a chance you lost money on a cryptocurrency investment. In that case, you can actually deduct the losses and offset your capital gains from other sales or profits.
For complete clarification and the answers to the question, “How do I pay taxes on crypto?” see the virtual currency FAQ page provided by the IRS.
When you own a piece of property and sell it or exchange it for another and gain a profit, how much you’ve made is pretty simple to determine. However, with virtual currency, it can be trickier since several trades can be made before actually making a sale. Additionally, you can exchange one type of crypto for another, but you can still be liable for taxes owed on the gain resulting from the trade.
The last thing you want to do is report the wrong amount for capital gains on your IRS form. Working with a tax attorney that has experience with crypto is recommended. This is especially true when frequent transactions take place. The way in which crypto is traded can affect whether the gain is classified as a short-term or long-term capital gain.
Frequent trades typically result in more short-term gains, which translates to larger tax bills. Holding on to a crypto investment for more than a year and then selling or trading it results in a long-term gain. Knowing the difference between the two, as well as the tax rates for each, is important.
Trading in crypto may have been hard for the IRS to track many years ago, but not anymore. It has become much easier for the IRS and other regulatory organizations to track each trade and identify traders. This was evidenced by the thousands of letters that were sent to crypto traders over the last few years. Those that try to trade anonymously might still be found in the future. The IRS’s Fraud Enforcement Office works with private organizations to identify individuals trading in crypto without reporting cryptocurrency gains.
As with any taxes, failure to pay taxes on crypto can result in severe penalties, including a garnishment of your wages, seizures of assets, and liens on your property. If you owe taxes on crypto but have already filed your taxes without indicating it, you can file an amended tax form.
If you trade with cryptocurrency exchanges, you can ask for reports that can be used to help you prepare your tax returns.
To make things easier when it comes time to prepare your taxes, get into the habit of tracking all your transactions. There are several apps that can help you do this. It’s a good idea for those who want to get more involved with crypto, since values change quickly and trades can happen frequently.
Before choosing a crypto portfolio tracker, be sure to read reviews and examine the features of each one. Many of them are free to try but then charge a monthly fee, so you’ll want to pick the one that works best for your needs.
So, you’ve learned that the answer to the question, “Do I pay taxes on crypto?” is a definite yes. And the IRS is getting very serious about making sure that all crypto traders properly report their gains and pay the proper taxes. As mentioned above, working with a tax professional that has experience with cryptocurrency is highly recommended. There’s also a lot of deductions that can be taken on capital gains, saving you some money as well.