New IRS Crypto Tax Rules: All New Crypto Holders Need to Know

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It is no secret that the world of cryptocurrencies has grown massively over the past decade. Widely perceived as the future of finance, it is necessary for every investor to understand how crypto tax laws operate, especially in a complex tax environment as in the United States.

How Is Cryptocurrency Taxed?

In the United States, the Internal Revenue Service (IRS) considers cryptocurrencies to be property. Therefore, standard property tax rules apply to cryptocurrencies. Whenever you acquire a cryptocurrency, such as Bitcoin, and it appreciates in value, you are expected to pay a capital gains tax on the profit when you sell it.

Crypto tax basics

When determining your cryptocurrency taxes, you must first establish the cost basis. This number consists of the original buying price plus any associated fees. As you transact with the cryptocurrency, whether you're buying additional coins, spending them, or selling them, these transactions alter your cost basis and may also induce tax events.

However, if you are “HODLing” (where “HODL” stands for “Hold on for Dear Life”) your cryptocurrency for a longer period without making transactions, your taxes might not be affected until you decide to sell.

Given the unique nature of cryptocurrencies, IRS auditors may not be fully informed about the intricacies linked to tracking these types of assets.

Therefore, the onus of proper record-keeping falls heavily on the clasp of cryptocurrency investors.

Types of trading & how are they taxed

Different types of trading activities can have different tax implications. Here's a brief outlook:

Buy and hold trades: If you buy and hold a cryptocurrency for over one year before you sell or trade it, your profit falls into the "long-term" capital gains tax category. These rates tend to be more favorable than short-term rates.

Day trading: Short-term trades imply that you buy and sell or trade your cryptocurrencies within one year of acquiring them. These profits are charged as ordinary income rather than at capital gains rates.

Mining: Income from mining cryptocurrencies is considered self-employed income and taxed at ordinary income tax rates.

Initial coin offering (ICO): Both investing in and developing ICOs can be taxable events. If you purchase tokens during an ICO, you will face no immediate tax.

However, you might be subjected to capital gains tax when you sell or trade your tokens.

If you're an ICO developer, any profit from the sale of the newly minted coins is typically considered income, thus taxed at income tax rates.

Taxes on Crypto Payments, Staking, and Mining

Cryptocurrencies aren't just employed for trading or investing; some also use them as a medium of exchange for goods and services, while others engage in activities like staking and mining.

Pay for goods/services with cryptocurrencies

Suppose you use your cryptocurrencies to pay for goods or services. In that case, every spent transaction qualifies as a taxable event where you're required to calculate and report the gain or loss compared to the cost basis of the used asset.

Staking cryptocurrencies

If you're staking your cryptocurrencies, the extra coins you receive can be deemed an “income” and thus taxable. The cost basis of these additional coins would be the fair market value on acquiring day.

Mining cryptocurrencies

When cryptocurrencies are mined, they are considered taxable income once they are obtained, with the value being the fair market value on the day of receipt. If the mined coins appreciate in value before they are eventually sold or traded, they can be subjected to capital gains tax as well.

Gifts & donations

Gifting your cryptocurrencies or donating them to a charity can potentially reduce your overall crypto tax impact. When cryptos are given as a gift, no immediate taxes are imposed. However, the receiver of the gift eventually assumes the cost basis for future transactions. Donating your digital assets to a charity could potentially make you eligible for a tax deduction, dependent on your tax situation.

Succession and inheritance

Cryptocurrencies received due to inheritance are subject to inheritance tax laws. This involves the cryptocurrency's fair market value at the date of the descent holder’s death. It's important to note, however, that inherited crypto-assets will be considered long-term holding from the date of the original owner's death, offering recipients a significant tax advantage.

Hard fork and airdrops

Airdrops and hard forks can also induce tax events. Should you receive new coins from an airdrop or a hard fork, you will be liable to pay income tax at the rate of the fair market value of the coins at the time you received them.

Record-Keeping and Reporting for Cryptocurrency Taxes

Accurate financial records are essential when filing your cryptocurrency-related taxes as errors can result in inquiries from the IRS, audits, or even fines. You should maintain vigilant records of every transaction you make involving your cryptocurrencies, including buying, selling, trading, transferring, staking, or donating them.

Documentation of all these activities should include the date of the transactions, the fair market value of the cryptocurrency on the date of the transaction, the purpose of the transaction, the resulting gain or loss, and the cost basis before and after the transaction.

Reporting of these transactions is done on IRS Form 8949, and the totals contribute to your Schedule D, which shows an overview of your capital gains and losses for the year.

If high-income thresholds are cleared, net investment income tax (NIIT) may become applicable on gains.

Given below is a list of fill-out tax forms:

  1. Form 1040: This standard tax form is where you'll report overall income sources, including capital gains or losses from cryptocurrency transactions.
  2. Form 8949: On this form, you'll specifically detail each of your cryptocurrency transactions. This includes information about the date of acquisition and sale, cost basis, and gain or loss.
  3. Schedule D (Form 1040): This schedule summarizes the total gains and losses from all forms of capital asset transactions, including cryptocurrencies. Information here will come from your completed Form 8949.
  4. Schedule 1 (Form 1040): If you've mined cryptocurrency as a self-employed individual or run a crypto-based business, you'll report income and expenses on this schedule.
  5. Schedule SE (Form 1040): This form computes self-employment tax for income from mined cryptocurrencies.
  6. Schedule C: If you have received cryptocurrency as a form of payment for goods or services from a business venture, these will be reported on Schedule C.

Remember, accurate record-keeping is not an option; it's a must when it comes to protecting yourself from audits and possible legal ramifications. It's always a good idea to work with a financial advisor or tax professional who's familiar with cryptocurrency taxes.

How Do I Avoid Crypto Capital Gains Tax?

The significant nature of cryptocurrencies results in a fair amount of taxation but knowing the proper legal ways to minimize taxes can be real game changers. Here's how:

  1. Hold your cryptocurrency for over a year: Long-term capital gains tax rates are generally more favorable than short-term rates. Therefore, holding your crypto for over a year before selling or trading could potentially lower your tax liability.
  2. Gift or donate your cryptocurrency: As mentioned earlier, giving your cryptocurrency as a gift or donating it to a qualified charity may help you lower your crypto tax bill.
  3. Use your cryptocurrency to purchase charitable deductions: In case you make charitable donations with your cryptocurrencies, you may be able to deduct the fair market value on the day of donation. Just ensure that the charity or organization is eligible for tax-deductible donations before making the transaction.
  4. Harvest your losses: Just as with traditional investments, you can "harvest" your cryptocurrency losses to potentially offset the gains you've made elsewhere. If you have experienced a notable decrease in your cryptocurrency's value, selling it to realize a capital loss and then repurchasing the same crypto could possibly counterbalance gains realized from other ventures.
  5. Time your investments: Timing your investment can prove quite profitable. Cycling your investments based on the tax year, for example, buying at the beginning of a tax year, holding for a year, and then selling the investment at the beginning of the next tax year could potentially balance capital gain liabilities.
  6. Watch out for wash sale rule violations: While the wash sale rule (selling at a loss and buying the same or similar security soon after) notably applies to stock and securities, it could potentially apply to cryptocurrencies under certain circumstances. Always ensure you are following all applicable laws.
  7. Leverage tax lot methods: Cryptocurrency allows for different manners of tracking cost basis through methods like FIFO (first in, first out), LIFO (last in, first out), and HIFO (highest in, first out). These methods make a significant difference in calculating capital gains or losses. Thus, using a tax lot method beneficial to your specific case might minimize your tax exposure considerably.

How To File Your Crypto Taxes in 2023

Despite the volatility and complex nature of cryptocurrencies, it's essential to be diligent with your tax filing to avoid complications with regulatory bodies. The following steps provide helpful guidance on how you can report crypto on your taxes for the 2023 tax season.

Step 1: Identify and gather your transactions

Firstly, consolidate all your crypto trading and transaction history for the year. This process involves scanning through each cryptocurrency exchange you've used and fetching your transaction logs.

Step 2: Calculate your gains and losses

With your transaction data, calculate your capital gains and losses. For each transaction, compute the cost basis, i.e., the original value of the cryptocurrency you disposed of, plus trail along costs such as remittance fees. This total is deducted from the coin's selling price to derive your gain or loss for the specific transaction. You can then aggregate all the transactions to get your total gains and losses.

Step 3: Fill and attach your forms

Once your capital gains and losses have been calculated, start filling out your tax forms.

As we have already discussed, forms include Form 1040, Form 8949, Schedule D, Schedule 1, Schedule SE, and Schedule C depending on your scenario. Remember to include all necessary details such as acquisition dates and gain or loss amounts. Unused deductions can be carried forward to your future tax years.

Step 4: File your federal and state returns

Submit your filled-out federal tax return (if you're in the United States), including your filled-out tax forms, as it states your overall capital gains and losses for the year to the Internal Revenue Service (IRS). As state laws vary, you should also consider the tax obligations in your particular state and file a separate state return if necessary.

Step 5: Pay any due taxes

Based on competitive rates from your cryptocurrency transactions, your calculated gains might lead to tax liability. Pay any due amount by the tax filing deadline to avoid penalties and interest.

Step 6: Revise your investment strategies for the upcoming year

The filing process gives you a comprehensive understanding of your tax obligations. Leveraging this understanding to adjust your strategies for the following year can help act extensively on tax-saving opportunities.

Frequently Asked Questions

Will crypto exchanges issue 1099s to the IRS?

Yes, the Internal Revenue Services allows cryptocurrency exchanges to issue 1099s for users who have disposed of their crypto holdings through the calendar year. However, not all exchanges provide 1099s, so you should keep a personal track of your trades via other exchange documents. Furthermore, remember that even without 1099, you are still obligated to report all taxable activities truthfully.

What happens if I don't report crypto taxes?

Ignoring crypto taxes might lead to an audit by tax authorities, and failing to comply with tax authorities could result in penalties. In extreme cases, blatant evasion can lead to imprisonment under the charges of tax fraud.

How are cryptocurrencies taxed?

Cryptocurrencies are generally considered property by tax authorities and are often subject to capital gains tax when they're disposed of. The tax rate applicable depends on the length of the holding period. If you've held the cryptocurrency for a year or less before you sell or use it, you would typically pay short-term capital gains taxes. Conversely, if you've held the cryptocurrency for more than a year, then you would most likely be subject to long-term capital gains rates.

If I mine cryptocurrencies, are these taxable?

Yes, mined cryptocurrencies are taxable. The IRS treats cryptocurrency mining as a taxable income-generation activity. As such, the fair market value of the mined cryptocurrency as of the date you gained its possession is usually included in gross income. If you're also classified as a self-employed miner, then Social Security and Medicare taxes might apply.

Can I avoid capital gains tax on crypto?

Though not entirely avoidable, you can reduce your net capital gains and, subsequently, the capital gains tax to some extent. This could be potentially achieved by using tax lot methods or “harvesting” losses by selling poor-performing cryptocurrencies before year-end. However, one should always be wary of not being found to violate the “wash sale” rule.

Are airdrops and forks taxable events?

Yes. The IRS-issued guidance confirms that both airdrops and forks typically cause taxable events.

Essentially, the issued or forked cryptocurrencies are considered income, which has to be reported and valued at their fair market prices at the time you secure full control over them.

Always ensure to include these activities in your gross income calculation, particularly if you involuntarily receive these assets due to a random event initiated by the project developers.

Is it legal to hold cryptocurrencies in different countries to avoid taxes?

Simply holding cryptocurrencies in different countries does not exempt you from paying taxes, as most regulations require you to report your crypto assets globally. Keep in mind that every country has its tax laws, so legal advice is strongly recommended before implementing such a strategy to ensure its legality and implications on your personal circumstances.

Is a gift of cryptocurrency subject to tax?

While the receiver generally would not be required to pay income tax on receiving crypto as a gift, there are potential tax implications for the giver. If a gift's value exceeds the annual exclusion limit, it may trigger a gift tax payable by the giver. Moreover, the receiver's eventual selling price may need the original cost basis of the giver to calculate potential capital gains or losses.

Can I buy anything with cryptocurrencies without having to pay taxes?

Any form of exchange of a cryptocurrency, including purchasing goods or services, is a taxable event and must be reported. The IRS treats these transactions as if you sold the cryptocurrency for fiat currency, and then used that money for the purchase, which may trigger capital gains tax.

What happens to my cryptocurrency when I die?

In most countries, cryptocurrencies are treated as assets, so they will be included in your estate after your death. Your beneficiaries could inherit your cryptocurrencies and would be responsible for handling any tax liabilities associated with them. They essentially acquire your base cost or “cost basis” at the time of transfer, so they might have to pay capital gains tax depending on the value at the time they decide to sell or use these cryptocurrencies. It is advisable for someone with cryptocurrencies to include their digital wallets in their will and provide necessary instructions or passwords to access them. It is also beneficial to consult with legal experts who are familiar with estate planning related to cryptocurrencies to ensure their proper succession.