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While many, if not most, cryptocurrency transactions are publicly viewable on blockchain networks, there’s another entity that has an interest in your crypto holdings: The Internal Revenue Service.
Given that crypto has grown increasingly popular, the IRS has grown interested in keeping taxpayers honest about their crypto-trading activity and digital assets. Crypto traders have tax liabilities when it comes to their holdings, be they bitcoin, Ethereum, or even Dogecoin.
But many involved in crypto may still not understand the ins and outs of the taxes involved, and how to report it all to the government.
The most important thing for investors to know is that crypto (or “digital assets,” as the IRS refers to them) is considered property, and taxed as such.
That property distinction is incredibly important, says Joe Howe, crypto tax manager at Crypto Tax Girl, a firm that specializes in helping crypto investors. Like stocks or real estate, it’s easy to trigger a taxable event, he says. When there’s a gain, you may owe taxes. If there’s a loss, you may be able to write it off.
“Every transaction done with crypto is a taxable event, outside of purchasing crypto with fiat money, such as US dollars,” says Howe. “The actual purchase is not a taxable event, but if you sell one coin for another coin, then you would owe taxes. If you spend the crypto on goods or services, that’s also a taxable event — one of the downfalls of the current guidelines is that any expenditure of the crypto is a taxable event,” he says.
Important: Non-fungible tokens, or NFTs, are taxed the same way that crypto coins or tokens are. Every NFT transaction is a taxable event, so investors who have sold NFTs should be prepared to report it on their tax return.
Capital gains tax is a tax on the profit made from selling an asset or investment, including crypto.
“It works exactly the same way that selling stocks works,” says Clinton Donnelly, president and founder of CryptoTaxAudit, a tax firm that works exclusively with crypto traders and defends people in IRS audits.
Here’s a simple example of how an investor may come to owe capital gains taxes on crypto holdings:
If two years ago you purchased $1,000 in bitcoin and today sold it for $2,000, you would realize a capital gain of $1,000. That would be subject to long-term capital gains taxes. If you are single and earn $50,000 a year, your capital gains tax rate is 15%. As such, you would owe $150 in capital gains taxes, triggered by your bitcoin sale.
As for a capital loss, assuming all other factors are the same, let’s say you purchased $1,000 in bitcoin two years ago. Today you sold it for $500. You have realized a capital loss of $500. Since you lost money, you don’t owe any capital gains taxes. But if you had other realized capital gains, you may be able to use the $500 loss to offset some of those gains and potentially lower your ultimate tax liability.
The special thing about crypto is that capital gains taxes apply not only when you sell, Donnelly says, but also when you pay for something. When you buy something and pay for it using cryptocurrency, that is a capital gains event since you’ve “effectively sold” the crypto in doing so, he says.
Capital gains taxes are partly determined by how long an asset is held. It’s considered short-term if held for less than a year. Otherwise, it’s a long-term gain. Short-term rates correspond to an individual’s ordinary income tax bracket, which could be as much as 37%. Long-term rates also depend on an individual’s filing status and taxable income but typically top out at 20%.
Further, investors should know that they are taxed on net capital gains, which is the difference between gains and losses.
So, if you were to realize a $100 capital gain on one sale, but a $95 capital loss on another sale in the same tax year, you would owe capital gains tax only on the $5 net gain. The tax rate, again, would depend on how long you held the asset, your income, and your filing status.
This table breaks down long-term capital gains rates for each filing status:
2022 rate
Single
Married filing jointly
Married filing separately
Head of household
0%
Up to $41,675
Up to $83,350
Up to $41,675
Up to $55,800
15%
$41,676–$459,750
$83,351–$517,200
$41,676–$258,600
$55,801–$488,500
20%
$459,751+
$517,201+
$285,601+
$488,501+
If you’re hoping to avoid crypto taxes, there isn’t much you can do other than stick to a buy-and-hold strategy.
That’s because only crypto transactions trigger taxable events — if you simply hold onto your crypto assets (and avoid buying goods and services), there’s no event to tax. “If you want to avoid crypto taxes, don’t sell it,” says Donnelly.
Howe says that you can also use a tax-deferred retirement account to avoid crypto taxes. “The best way that you may be able to avoid taxes is to set up a self-directed IRA and purchase crypto through that,” he says. “It is a bit challenging, but it’s an option for people.”
Most states have yet to issue guidance on how gains from cryptocurrency transactions are taxed, so you probably won’t have a tax liability at the state level.
Quick tip: All crypto transactions are taxable events. That includes when someone receives crypto without paying for it — such as via an “airdrop” or through staking rewards.
The IRS asks point blank on Form 1040: “Did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”
If you check “yes,” then you’ll have to fill out Form 8949 to calculate your capital gains or losses. While some big crypto exchanges such as Coinbase and Kraken send investors transaction information to help them complete their tax returns, investors who trade and operate largely on their own through numerous exchanges or decentralized exchanges will need to keep track of transactions themselves.
“We highly recommend keeping a crypto tax software to keep things organized,” Howe says. “Most people have thousands of transactions, and it can get dicey trying to sort it all out.” Howe’s team recommends platforms such as CoinTracking, Koinly, or CoinLedger as starting points.
This all may require some legwork. But experts say it’s important to take crypto tax reporting seriously. Investors need to be honest about their holdings and activity.
“It’s a yes or no question,” Donnelly says, and “if you say ‘no’ and you mean ‘yes,’ that turns your tax return into a fraudulent return.”
The IRS has gone relatively easy on crypto investors, Donnelly adds. But that’s changing.
“The IRS hasn’t been as aggressive as they could be, but we’re going to see a new IRS in the coming years,” he says.
The most important things for investors to keep in mind are that crypto is currently taxed as property — like stocks or real estate — and that any transaction will trigger the capital gains tax if you’re trading in a traditional brokerage account.
Long-term capital gains tax rates apply to profits you earn on a crypto investment held for longer than a year, while short-term capital gains tax rates apply to profits on an investment held for less than a year. You may not ultimately owe tax if you have investment losses that you can use to offset your gains, but you still have to report all of it.
And if you’ve been lax about reporting crypto profits in the past, it’s time to be upfront. “My advice is to start being compliant now, and go back and fix your previous returns,” Donnelly says.
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