Cryptocurrency taxes: A guide to tax rules for Bitcoin, Ethereum and more
With the staggering rise in the value of some cryptocurrencies such as Bitcoin and Ethereum, crypto traders and enthusiasts may have serious tax questions on their minds. With the Internal Revenue Service (IRS) stepping up enforcement efforts, even those who hold the currency — let alone trade it — need to make sure they don’t run afoul of the law. That might be easier to do than you think, given how the IRS treats cryptocurrency.
“It’s a really big enforcement area for the IRS right now,” says Brian R. Harris, tax attorney at Fogarty Mueller Harris, PLLC in Tampa. “They’re generating a lot of publicity in going after people who hold, trade or use cryptocurrency. Those people can be a target for audit or compliance verification.”
While one of the selling points of Bitcoin, for example, has been its anonymity (or at least semi-anonymity), authorities have been playing catch-up in recent years with some success.
“The IRS and FBI are getting better at tracking and tracing Bitcoin as part of criminal investigations,” says Harris. And they can freeze assets, if needed, he adds.
So it’s all the more reason for those who transact in cryptocurrencies to know the law and what taxes they might be incurring by their actions. The good news: The IRS treats cryptocurrencies similarly to how it treats other capital assets such as stocks and bonds. The bad news: That treatment also makes it difficult to actually use cryptocurrency to buy goods and services.
Here are a number of key things you need to know about cryptocurrency taxes and how to stay on the right side of the law.
Topics covered on this page
- You’ll be asked whether you owned or used cryptocurrency
- You don’t escape being taxed just because you didn’t get a 1099
- Just using crypto exposes you to potential tax liability
- Gains on crypto trading are treated like regular capital gains
- Crypto miners may be treated differently from others
- A gift of crypto is treated the same as other gifts
- Inherited cryptocurrency is treated like other inherited assets
- Bottom line
7 things you need to know about cryptocurrency taxes
1. You’ll be asked whether you owned or used cryptocurrency
Your 2021 tax return requires you to state whether you’ve transacted in cryptocurrency. In a clear place near the top, Form 1040 asks, “At any time during 2021, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
So you’re on the hook to answer definitively whether you’ve transacted in cryptocurrency, putting you in a position to potentially lie to the IRS. If you don’t answer honestly, you could be in further legal jeopardy, and the IRS does not look kindly on liars and tax cheats.
However, there is a footnote. In a recent clarification, the IRS said that taxpayers who only purchased virtual currency with real currency were not obligated to answer “yes” to the question.
2. You don’t escape being taxed just because you didn’t get a 1099
With a bank or brokerage, you (and the IRS) will typically get a Form 1099 reporting the income you’ve received during the year. That may not be the case with cryptocurrency, however.
“There isn’t really the same level of reporting yet for cryptocurrency, relative to typical 1099 forms for stocks, interest and other payments,” says Harris. “The IRS doesn’t get great reporting from Coinbase and other exchanges.”
However, a November 2021 law will require greater tax reporting for those in the industry starting on Jan. 1, 2023. The law requires brokers – including controversially, anyone who moves digital assets for another – to report that info to the IRS on a 1099 or similar form.
Opponents say the law would require anyone who moves cryptocurrency, including miners and crypto wallets, to the new rules, including those who have no access to that info. However, lawmakers are already working on a new bill to more narrowly define who the law applies to.
But the lack of a 1099 won’t let you escape any tax liability, and you’ll still have to report your gains and pay tax on them. Still, it’s not all bad news: If you had to take a capital loss, you can deduct that on your return and reduce your taxable income.
3. Just using crypto exposes you to potential tax liability
You might think that if you only use – but not trade – cryptocurrency you’re not liable for taxes.
Any time you exchange virtual currency for real currency, goods or services, you may create a tax liability. You’ll create a liability if the price you realize for your cryptocurrency – the value of the good or real currency you receive – is greater than your cost basis in the cryptocurrency. So if you get more value than you put into the cryptocurrency, you’ve got yourself a tax liability.
Of course, you could just as well have a tax loss, if the value of goods, services or real currency is below your cost basis in the cryptocurrency.
In either case, you’ll have to know your cost basis to make the calculation.
It’s important to note that this is not a transaction tax. It’s a capital gains tax – a tax on the realized change in value of the cryptocurrency. And like stock that you buy and hold, if you don’t exchange the cryptocurrency for something else, you haven’t realized a gain or loss.
4. Gains on crypto trading are treated like regular capital gains
So you’ve realized a gain on a profitable trade or purchase? The IRS generally treats gains on cryptocurrency the same way it treats any kind of capital gain.
That is, you’ll pay ordinary tax rates on short-term capital gains (up to 37 percent in 2021 and 2022, depending on your income) for assets held less than a year. But for assets held longer than a year, you’ll pay long-term capital gains tax, likely at a lower rate (0, 15 and 20 percent).
And the same rules for netting capital gains and losses against each other also applies to cryptocurrencies. So you can deduct capital losses and realize a net loss of up to $3,000 each year. If your net losses exceed this amount, you’ll have to carry them over to the next year.
5. Crypto miners may be treated differently from others
Do you mine cryptocurrency as a business? Then you might be able to deduct your expenses, as a typical business would. Your revenue is the value of what you produce.
“If you mine cryptocurrency, you realize income at the fair market value, so that’s your basis in the cryptocurrency,” says Harris. “If this is a trade or business, your expenses may be deductible.”
But that last bit is the key point: You have to be running a trade or business to qualify. You can’t operate your mining rig as a hobby and enjoy the same deductions as an actual business.
6. A gift of crypto is treated the same as other gifts
If you’ve given cryptocurrency to someone, perhaps a younger relative as a way to spark interest, your gift will be treated the same way as any similar gift would be. So it can be subject to the gift tax if it’s over $15,000 in 2021 (or $16,000 in 2022). And if it comes time for the recipient to sell the gift, the cost basis remains the same as the giver’s cost basis.
That said, there are some ways to escape the gift tax, even if you go over the annual threshold, such as taking advantage of the lifetime exemption.
7. Inherited cryptocurrency is treated like other inherited assets
Inherited cryptocurrency is treated like other capital assets that are passed from one generation to another. They may be subject to estate taxes if the estate exceeds certain thresholds ($11.7 million and $12.06 million in 2021 and 2022, respectively).
Like stock, cryptocurrency enjoys a stepped-up cost basis to the fair value on the day of death. So generally, cryptocurrency is treated for most people like a typical capital asset, says Harris.
It can be surprisingly onerous to actually use cryptocurrencies, from tracking your cost basis, noting your effective realized price and then potentially owing tax (even without an official Form 1099 statement). Plus, the IRS is stepping up enforcement and surveillance on potential tax evasion by looking more closely at who’s exchanging cryptocurrencies. All these factors help make cryptocurrencies more difficult to use and likely stymie their broader rollout.
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