How Is Cryptocurrency Taxed?

The buzzwords "decentralized" and "centralized" finance have taken on new meanings in recent years, as the rise of cryptocurrency and other digital assets has transformed how we think about money. But no matter which type of finance you're using, the one thing remains constant - the need to pay taxes.

Do you have to pay taxes on cryptocurrency profits? Yes. Let's cover when you need to pay taxes on your crypto, what types of transactions trigger a tax event, and how to calculate the amount of tax you owe.

Treatment as Property for Tax Purposes

The Internal Revenue Service (IRS) considers cryptocurrency a property rather than a currency. Similar to selling other types of property, such as a house, personal-use items, stocks, bonds, and other investments - the sale or exchange of cryptocurrency is subject to capital gains tax for Federal income tax purposes.

However, it's considered ordinary income if someone pays you with cryptocurrency for your services, you sell goods, or you earn cryptocurrency by mining or staking.

There is a distinction between capital gains and income, and the tax treatment of the two types of taxable events is typically different.

Taxable and Non-Taxable Events

A taxable event is any occurrence that triggers a tax liability, while a non-taxable event does not trigger a tax liability. Both events are determined by the Internal Revenue Service (IRS) based on the Internal Revenue Code and other tax laws and regulations.

For example, if you sell your cryptocurrency or other investment property, you will realize a profit or loss. This profit or loss may be subject to capital gains tax. Another example of a taxable event is receiving cryptocurrency for services or earning staking rewards because it's considered ordinary income.

Capital Gains vs. Ordinary Income Tax

A taxable event is considered a capital gain if it involves the sale or exchange of a capital asset. A capital asset is a property of any kind, including cryptocurrency. The profits from the sale of a capital asset are subject to capital gains tax.

Taxable events that involve earning wages or salary from employment, self-employment, or business activities are considered ordinary income and are typically subject to income tax.

You must accurately report any capital gains and ordinary income you earn on your tax return, as the IRS has different tax rates for these types of income.

The following are some examples of taxable events that are either capital gains or ordinary income:

Taxable as Capital Gains

• Selling cryptocurrency for cash or other property
• Trading cryptocurrency for other cryptocurrencies
• Spending crypto on goods and services

Taxable as Income

• Getting paid in crypto
• Mining crypto or earning staking rewards
• Getting an airdrop

Non-Taxable Events

The Internal Revenue Service (IRS) determines what transactions and activities constitute a non-taxable event and provides information about non-taxable events on the website and through other resources and publications. Here are examples of non-taxable events:

• Buying crypto with cash and holding it as an investment
• Transferring crypto between your wallets or accounts
• Donating crypto to a qualified tax-exempt charity or non-profit
• Receiving or giving a gift in cryptocurrency is not considered a taxable event unless this gift exceeds $15,000 in value

Some events are not subject to taxation but may still require reporting to the Internal Revenue Service (IRS).

Capital Gains Tax Rates

Capital gain tax is a tax on the profit or loss you realize when you sell a capital asset. The tax is calculated on the difference between the asset's sale price and the cost you paid to acquire it. If you profit by selling an asset for a higher price than you paid, you incur a capital gain which is subject to capital gains tax. If you sell an asset for a lower price than you paid, you incur a capital loss, which you may be able to use to offset capital gains and reduce your tax liability.

Capital gains are taxed differently depending on how long you owned your assets before selling them. The federal government classifies capital gains as either short-term or long-term for tax purposes.

Short-Term and Long-Term Capital Gains Tax Rates

As with other investments, the tax rate applied to your cryptocurrency gains or losses depends on whether you held the cryptocurrency for more than one year (long-term) or for one year or less (short-term). The federal government generally taxes long-term capital gains at a lower rate than short-term gains. Short-term capital gains are taxed at the same rate as ordinary income.

For most people, the tax rate on long-term capital gains is 15%. Some or all net capital gains may be taxed at 0% if your taxable income is:

• Less than or equal to $40,400 for single taxpayers
• Less than or equal to $80,800 for married taxpayers filing jointly or qualifying widow(er)

A capital gain rate of 15% applies if you sell or exchange an asset you have held for more than a year and your taxable income is:

• More than $40,400 but less than or equal to $445,850 for single taxpayers
• More than $80,800 but less than or equal to $501,600 for married taxpayers filing jointly or qualifying widow(er)
• More than $54,100 but less than or equal to $473,750 for the head of household
• More than $40,400 but less than or equal to $250,800 for married taxpayers filing separately

If your taxable income exceeds the thresholds that IRS set for the 15% capital gain rate, the gains above these thresholds will be taxed at 20%.

If you sell or exchange it an asset that you have held for less than a year, any profit you make from the sale is considered a short-term capital gain and will be taxed as ordinary income at the tax rates based on your income level.

Note that the tax rates and rules described in this article are current at the time of writing. Verify the current tax rates and thresholds on the Internal Revenue Service (IRS) website or consult a tax professional before preparing your tax return.

How to Calculate Your Gain or Loss

First, you need to determine the cost basis of your crypto asset. Cost basis is the amount of money you have invested in an asset, including any costs associated with buying or selling it. The cost basis is the sum of the following:

• The purchase price of the crypto asset: The price you paid in U.S. dollars for the asset when you acquired it.
• Any costs associated with the sale: The cost may include broker's fees, commissions, or other expenses incurred in the sale of the asset in U.S. dollars.

To calculate your gain or loss on the sale of a crypto asset, subtract the cost basis from the price you received when you sold it. If the result is positive, you have a gain that you should report on your Federal income tax return. If the result is negative, you have a loss, which you can use to reduce taxes on future capital gains.

Ordinary Income Taxes

If you receive cryptocurrency as ordinary income, you will be required to pay income tax on the fair market value of the cryptocurrency at the time it was received. The tax rate you pay will depend on your federal tax brackets and the tax laws of your state. Receiving payments as an independent contractor is considered self-employment income and is likely subject to self-employment tax in addition to income tax.