Do I Need to Pay Taxes on Cryptocurrency?

Cryptocurrency has gained a huge amount of traction over the past couple of years. Due to the volatility of these cryptocurrencies investors are constantly trying to buy low and sell high. However, they rarely pause to think how all these sales and purchases will affect them come tax time.

Despite cryptocurrency lacking government oversight, it is taxed as a capital asset. That means you may owe taxes on realized gains or losses from the sale or exchange of cryptocurrency.

In this article, we will give you all of the information that you need in order to know about how cryptocurrencies are taxed and how to cut down on those taxes so that you don’t end up with a surprisingly large bill come tax time.

How is Cryptocurrency Taxed?

Cryptocurrency is considered property and is taxed as a capital asset. Tax occurs on cryptocurrency when a “realization event” occurs. How you pay taxes on cryptocurrency depends on two key variables:

  • How did you obtain the currency (i.e. was it mined or purchased?)
  • How long did you hold the cryptocurrency for?

Let’s take a look at how these two variables will impact how much money you owe in taxes at the end of the year.

Short-Term vs. Long-Term Gains

Much like stocks, cryptocurrency that is bought as an asset is taxed based on the length of time that you hold said asset. You pay taxes on the profit of realized gains. In other words, you pay taxes on the difference between the price you sold the cryptocurrency at and the price you bought it at.

A short-term gain is considered an asset that is bought and sold within a 365-day period. Short-term gains are taxed as ordinary income and subject to whatever tax bracket that you fall into within a given year. In 2021 the tax rate is between 10% and 37%.

Alternatively, a long-term gain is an asset that you buy and then sell after the 365-day period. Long-term gains are taxed between 0% and 20%. Therefore, if you hold a cryptocurrency long enough it could result in you keeping a much larger portion of that sale.

Cryptocurrency Mining is Taxed as Income

Mining cryptocurrency works a little differently than buying and selling cryptocurrency as an asset. The “realization event” for mining cryptocurrency occurs as soon as you mine the currency. You are obligated to pay taxes on the fair market value of the cryptocurrency at the time it was mined.

Cryptocurrency that was mined is treated just like taxable income. That means you will pay the same tax rate as you do for your short-term gains.

A second taxable event occurs if you decide to sell the cryptocurrency that you have mined. In this instance, you are taxed on the difference between the price you sold the crypto at and the value of the crypto when it was mined.

The good news is, if you’ve held the mined cryptocurrency for more than 365 days it can be taxed as a long-term capital gain.

Do I Need to Pay Taxes on Cryptocurrency Used for Purchases?

Now that several notable companies have started accepting cryptocurrencies like Bitcoin as a form of payment the tax situation gets even more complicated.

If you purchased a Tesla with US Dollars you would be charged whatever sales taxes are applicable to that purchase. However, if you purchased a Tesla using Bitcoin you would be charged a capital gains tax on the realized gains of the Bitcoin at the time of purchase in addition to the typical sales tax.

That means that if you made money from the “sale” of the Bitcoin at the time of purchasing your Tesla, you could potentially end up with an additional tax bill on top of what you are being taxed when purchasing the Tesla. This is an important consideration when purchasing anything using Bitcoin.

How Do I Minimize Cryptocurrency Taxes?

Now that we’ve looked at all the ways you can get taxed through buying and selling crypto, let’s dive into how you can help minimize these taxes.

Keep Detailed Records of Your Crypto Exchanges

Cryptocurrency exchanges and mining companies are required to report your activities on their platforms to the IRS, but that does not necessarily mean that you’ll be receiving tax documentation from them come the end of the year.

For this reason, it is essential to keep detailed records of all your cryptocurrency exchanges. In particular, you should note:

  • The price you purchased the cryptocurrency at
  • The price you sold the cryptocurrency at
  • The length of time you held the cryptocurrency

Keeping detailed records will help you avoid fees and penalties from the IRS for incorrectly reporting your taxable income.

Invest for the Long-Term

Not only does investing in the long-term usually result in better gains, but it can also help reduce your tax burden. As long as you hold a cryptocurrency for more than 365 days it will be taxed as a long-term capital asset.

As discussed earlier in this article, the long-term capital gains tax is significantly lower than the short-term one. Take this into consideration when trying to buy and sell on every dip and rise. Holding on to your crypto for a little bit longer might actually make you more money in the long run.

Offset Your Gains with Losses

Another way to help reduce your tax burden is by offsetting capital gains with losses. You can deduct your losses from your gains and only be taxed on the difference.

Additionally, if you lost money on crypto, you can use up to $3,000 to offset taxes on your source of income. Any amount above the $3,000 can be rolled over into the next year.

The only caveat is that losses must be taken from the same type of gain. For example, you must use long-term losses to offset long-term gains and short-term losses to offset short-term gains.

Take Deductions for Mining Cryptocurrency

If you set up a business for the cryptocurrency that you mine, you can and should take tax deductions. Some of the common deductions include:

  • Equipment costs
  • Electricity costs (you must be able to determine electricity solely used for the machines)
  • Equipment repair
  • Rented space

You can save quite a bit of money if you set up a business for your crypto mining. However, be aware that you will be subject to self-employment tax as well if you decide to do this.

When Do I Need Help Determining My Cryptocurrency Taxes?

If all of this seems a little bit overwhelming or if it’s your first time filing taxes with cryptocurrencies do not fret! If you contact us we can help you determine if you owe taxes on your cryptocurrencies and how much you owe. We can also help ensure that you take all of the deductions you are entitled to. Reach out today to start working on calculating your cryptocurrency taxes.

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