When cryptocurrencies were first introduced, a scramble to create digital wallets and mining operations occurred. In the early days of these efforts, the IRS didn’t know how to treat the profits and losses that occurred through crypto trading.
As the markets have matured and more people have gotten involved with the hundreds of different crypto options, the IRS decided that more formalized structures were necessary to ensure people paid their fair share of taxes.
That led the agency to define what does and does not count as a taxable event.
Is Converting Crypto a Taxable Event?
The Internal Revenue Service (IRS) stated in June 2021 that converting crypto is a taxable event, even when trading it for another one. Taxes must be paid on the gains through calculations based on whether they occur within 12 months, or the asset was held for a longer time. It’s not recognized as a simple exchange.
An easy way to think about how to manage cryptocurrencies in your portfolio is to view them as stocks.
If you purchase a stock, there isn’t a tax applied to the transaction. The exchange is recognized as a like-for-like event.
You could buy 1,000 shares of Apple stock without any tax consequences from the purchase.
When you sell that Apple stock, there could be tax obligations to consider. The first test is to determine if you earned a profit on your transaction. If you did, then you pay a different rate if you owned the stock for 12 months or less than if you held it for more than a year.
If you sold the Apple stock to buy Microsoft stock, the change would still encounter a taxation event because those are not like-for-like transactions, even though you’re getting a different share.
If you convert Bitcoin to Ethereum, the same result occurs. The IRS sees you generating a capital gain or loss, so the results must become part of your finances. You’ll be asked on your tax return for this information, including whatever gains or losses you experienced.
The comparison between cryptocurrency and stocks is accurate because the Internal Revenue Service classifies crypto as property, not a currency. That’s why incomes related to these exchanges are classified as capital gains.
What Am I Required to Report?
In the United States, all taxpayers who trade cryptocurrencies are required to report their activities to the Internal Revenue Service. That means about one out of every ten returns should include this information.
The IRS needs to see all your crypto conversions, payments, sales, and income. Some states also want this information when filing your annual return.
Each transaction has a different tax implication to consider. Knowing how and when your crypto gets taxed can help you minimize your obligations in this area.
Before proceeding, please remember that this information is not legal tax advice. It should be treated as this writer’s personal reflection of the current IRS guidance regarding cryptocurrencies, which is subject to change at any time. Do not use this information as individual advice or a specific recommendation. Please consult with a knowledgeable crypto tax attorney and your CPA for specific questions that involve your circumstances.
Do I Owe Taxes on My Crypto Activities?
Cryptocurrencies are considered digital assets in the United States instead of a fiat-style currency. Although you can use crypto to buy and sell goods from an electronic wallet, the IRS sees this activity as a barter, not a transaction.
It would be like trading an expensive car for a new house without having any dollars transferred with the exchange. Each person would become the new owner of the asset in question.
That causes the Internal Revenue Service to treat crypto like a capital asset, such as stocks and bonds. The money you get from cryptocurrencies is taxed as income or capital gains depending on how you obtained the investment and how long you held it.
If you’re wondering if you owe taxes on your activities, it’s essential to look at how you were using crypto over the past year.
Those events are broken into three categories: taxable as capital gains, taxable as income, and non-taxable.
Here’s a closer look at some of the different circumstances you might encounter when buying, selling, and trading your favorite cryptocurrencies.
| Non-Taxable Events | Capital Gains Events | Income Events |
| You decided to purchase crypto with cash and held onto the asset. Buying to own isn’t a taxable event, but taxes are often incurred when gains are realized. | You owe taxes when selling crypto for U.S. dollars or another preferred fiat currency. If the asset turns a profit, you’ll owe the IRS a percentage. When it is at a loss, there could be a deduction. | You wanted to receive your paycheck in cryptocurrency. NFL player Russell Okung asked for this option in 2021. You’ll pay income tax on it like you would receive a check in a preferred fiat currency based on your income bracket. |
| The cryptocurrency was donated to a qualifying tax-exempt non-profit organization or charity. It must have been to a 501(c)(3) organization. | You converted one cryptocurrency for another. If you buy Litecoin with Bitcoin, you’re technically selling one crypto to then buy another. That sale is what becomes taxable. | If you receive cryptocurrency in exchange for goods or services rendered, you must report this transaction as income to the IRS, just like someone who paid with a credit card. |
| The cryptocurrency was received as a gift. Until it is sold or exchanged for a different crypto, it can be held without a tax penalty. | If you spend crypto to purchase goods or services, you’ll need to pay taxes. The IRS sees you needing to sell the asset before it becomes exchangeable. | You are involved in crypto mining. This activity is often treated as a business venture where you owe taxes on the fair market value of your earnings. It is considered self-employment by the IRS. |
| You decided to give someone crypto as a gift. The 2021 tax year permitted gifts of up to $15,000 per recipient without tax, and higher amounts could be given to spouses. | You earned staking rewards or got it from a hard fork. They’re often based on the fair market value on the day they’re received, but guidelines often change. | |
| You transferred cryptocurrency from one account or digital wallet to another. | You earned “dividends” with your crypto. It is treated differently than interest from a bank or a direct payment received as a shareholder. |
This list isn’t comprehensive. You might receive free cryptocurrency for several reasons, such as obtaining a small deposit of Bitcoin for referring a friend to your digital wallet provider. Some marketing campaigns or company giveaways might offer an airdrop.
Both of those options would count as taxable income because you received property. The fair market value would be reported on your tax return.
What If I Just Want to Hold My Cryptocurrency?
If you decide to hold your cryptocurrency, the value in your digital wallet or account becomes like the money in a savings account. It can stay there for as long as you want to keep it.
It’s also like the stocks you might hold in an investment account. There isn’t a tax to purchase the ones you want, and they can go up or down in value while holding them. Even if they go up by thousands of dollars, there isn’t a tax obligation in most circumstances until the decision is made to sell or exchange the crypto.
Some crypto holders may find that holding their cryptocurrency is advantageous to their tax situation. Short-term gains are taxed at a different rate than long-term ones. Most people find that they’ll pay a lower rate if they hold onto their crypto for at least a year than if they sell it immediately.
- Short-term gains are typically taxed as ordinary income at that rate, which is typically higher for most people. It is based on your current progressive bracket in the U.S. tax code. In 2021, single filers who earned more than $40,525 would pay 22% or more on their additional earnings. Anything above $523,600 was taxed at 37%. Married couples can double those figures up until the 35% bracket, while heads of households have a little more income leeway.
- Long-term gains are taxed at the current capital gains rate. The highest level in this category is 20%, but there are 0% and 15% levels based on individual income. People with a high income have a 3.8% net investment income tax on these gains and other income.
Taxable events happen whenever you experience a gain or a loss. The only way that remains unrealized is if you continuously own the original asset that was purchased or given to you.
What If I Lost Money During a Crypto Exchange?
When you sell crypto for less than what you paid for it, the IRS considers that transaction to be a capital loss.
Although you’re losing money in that exchange, the losses can create an advantage for some traders. You can use them to offset the capital gains you experienced from sales of other capital assets, including stocks or bonds.
This outcome occurs on a dollar-for-dollar basis for American taxpayers, providing an opportunity to reduce the tax bill.
If you had no gains at all or more losses than gains, the maximum amount you can declare to offset other income in 2021 is $3,000.
Anything above that amount carries over to the next tax year until the entire amount is applied to your income.
Is It Worth Exchanging Crypto?
Exchanging crypto is an easy way to diversify a digital wallet, especially for investors who want to expand their cryptocurrency holdings. It does carry some tax consequences with it, even when the asset comes from the same digital wallet. The best way to avoid a tax issue would be to exchange dollars for the new crypto.
When you want to invest in other crypto options besides the major names in the industry, it isn’t always easy to get your hands on those assets. Even when you work with an established digital wallet provider and trading platform, you’re often asked to buy one crypto, then exchange it for the other.
That action creates a taxable event, according to the IRS. Even though you’re making a direct exchange, the crypto-for-crypto is seen as a multi-process transaction that requires a sale to proceed with a buy.
This perspective is the reason why low-level investors might consider staying away from some of the smaller crypto options.
Although you could make up the tax responsibilities relatively quickly, you’re essentially getting taxed twice or three times for that investment.
Here’s why it becomes problematic.
- You receive a nice bonus from work, so you decide to put that money into cryptocurrency. This fiat currency gets taxed as normal income and likely has withholdings reported by your employer.
- The crypto you want to purchase is priced at $0.000012, but it has a lot of good up-and-down movement.
- Your platform requires you to purchase Bitcoin or Ethereum. No tax is required for the purchase of the initial crypto.
- You exchange the first cryptocurrency for the second one. This activity results in a tax obligation to the IRS.
- After you hold the new cryptocurrency for 13 months, you decide that it’s time to go in a different direction for your finances. The platform requires you to exchange it back for Bitcoin or Ethereum. This activity results in another tax obligation to the IRS.
- You exchange Bitcoin or Ethereum for cash. This activity is yet another tax obligation to report under the current rules.
That exchange is the reason why the IRS rules for crypto can be confusing. It’s also why buying one cryptocurrency without exchanging it is often advantageous to the average person.
This field is ever-evolving, so please remember to review the tax rules each year before filing your return. It also helps to consult with an experienced and licensed tax professional if you have any specific questions regarding your situation.
