A US Guide to Crypto Taxes

Disclaimer
The following information is provided completely by ZenLedger and should not be considered as formal tax advice. The information is provided as-is at the date of publication, and given the fast-moving state of the crypto industry, may be subjected to changes in the future. CoinGecko is not responsible for the accuracy of the information, and for any consequences, intended or otherwise, arising from actions taken based on this article. For more information on crypto-taxes please visit ZenLedger or consult a licensed tax professional in your jurisdiction.

Just a decade ago, not many people knew about Bitcoin or blockchain technology. Now, the cryptocurrency market is worth trillions of dollars with tens of thousands of cryptocurrencies being traded daily. Suffice to say, there are now a lot of people trading and investing in cryptocurrencies. As a result of such prominence, particularly in the United States, there has been an increased focus from the Inland Revenue Service (IRS) on crypto-gains and investors paying their share of tax on crypto.

In this article, you will learn what kind of crypto transactions are taxable, how to calculate your crypto taxes, and how to prepare for the crypto tax season.

How is Cryptocurrency Taxed?

The IRS considers cryptocurrency as a form of "property". This means that they are taxed similar to real estate or stocks. As such, you would need to be familiar with a couple of terms:

Capital gain = this is when you earn from trading cryptocurrencies over the past year.

• If you purchase 1 Bitcoin for $40,000 but sell it for $50,000, then you would be declaring a capital gain of $10,000

Capital loss = this is when you lose money trading cryptocurrencies over the past year.

• If you purchase 1 Bitcoin for $40,000 but sell it for $30,000, then you would be declaring a capital loss of $10,000

You would also need to understand the cost basis of your cryptocurrency. The aim is to figure out how much you spent acquiring your cryptocurrency including transaction fees, brokerage commissions, and other related costs. This is important for determining your taxable gains.

To calculate your crypto cost basis, you can use this simple formula:

(Purchase Price + Fees) / Quantity

However, it also depends on the accounting method that you use:

• Calculating Crypto Taxes with FIFO (First in First Out) - The cost basis for a sale is the cost basis of the earliest crypto that you acquired.

• Calculating Crypto Taxes with LIFO (Last in First Out) - The cost basis for a sale is the cost basis of the last crypto that you acquired.

• Calculating Crypto Taxes with HIFO (Highest in First Out) - The cost basis for a sale is the cost basis of the most expensive crypto that you acquired.

You can read more about cost basis here.

How to Calculate Your Crypto Taxes with Examples

Before calculating your crypto taxes, you would need to know what are the taxable and non-taxable transactions.

Taxable transactions:

• Selling crypto for fiat (regardless of profit or loss)

• Trading one crypto asset for another

• Receiving crypto as a result of a hard fork/mining

• Receiving crypto from staking/liquidity pools

• Using crypto to pay for goods and/or services

Non-taxable transactions:

• Purchasing cryptocurrency

• Holding cryptocurrency

• Transferring cryptocurrency between wallets

• Receiving a cryptocurrency gift (if it does not exceed $15,000)

• Receiving a cryptocurrency donation

As a recipient of a gift, you won't be taxed until you sell the crypto. As a sender of a gift, you are only required to file a gift tax return if your gift exceeds $15,000. Charitable contributions are considered non-taxable transactions. And if you donate directly to a 501 (3) charitable organization, you can claim a charitable deduction equal to the fair market value of the donated cryptocurrency.

Once you identify which crypto transactions are taxable, you can then calculate the tax rate. Note that crypto may be taxed either at the capital gains tax rate or income tax rate depending on if it’s a capital gain/loss or ordinary income.

Income tax event:

• Receiving crypto from an Airdrop

• Earning interest on crypto through DeFi platforms or CeFi platforms

• Earning crypto from staking or mining pools

• Earning crypto from forks

Calculating capital gains tax rate

The applicable capital gains rate changes every 365 days from when you transact and hodl a particular crypto. Stocks held longer than that are taxed at a long-term capital gains rate, which is lower than a short-term capital gains rate. This is why many investors prefer to hold stocks and crypto for longer than a year.

Depending on your overall income, you may be charged a tax rate as follows:

• Short-term capital gains rate = 10-37%

  • Example: An investor may have made 4 buy trades and 1 sell trade, and they were all within the span of a year. Under the FIFO method, we would compare the difference between the first buy trade with the sell trade. Assuming that the investor made a profit from these two trades, the gains would be taxed at the short-term capital gains rate.

• Long-term capital gains rate = 0-20%

  • Example: Consider a similar scenario as above, but instead of the sell trade being executed within the span of a year, it is executed after a year from the first trade, say 400 days later. In this case, the gains made between the first buy trade and the sell trade would only be taxed at the long-term capital gains rate.

Losses from hacks or thefts

If your funds are stolen or hacked, they are considered as losses and you can use them to offset capital gains. Alternatively, you can deduct up to $3,000 from your income tax. Keep in mind that the IRS has separate categories for specific “losses” which may affect your cryptocurrency taxes. For example, sending crypto to the wrong address would be considered negligible and therefore not qualified for a tax deduction. Similarly, some hacks or rug pulls are not covered and are considered negligible as well. DYOR before apeing into any DeFi protocol.

Tax-loss harvesting

In certain situations, it might be better to sell specific cryptocurrency assets that may reduce your tax liability. The idea is to sell cryptocurrencies that are currently trading at a loss as part of an overall tax-loss harvesting strategy. In short, you would sell crypto assets at a loss to save money on crypto taxes.

Say that you have made $100,000 trading cryptocurrencies this year. However, there is a sudden bear market and you've decided to sell $10,000 worth of cryptocurrency at a loss. As a result, you would save money on your overall cryptocurrency taxes for the year.

Here is an example of using losses to offset capital gains AND deduct up to $3,000 off your normal income tax.

Say you own a selection of crypto assets and company stocks. Your stocks performed well and you made a $10,000 profit this year. You cashed that out and it's subjected to capital gains tax. However, your crypto assets performed badly. You lost $15,000 and decided to cash out. Because you have a net loss across all of your capital assets, you're able to offset the capital gains owed for the $10,000 profit to zero. You can also use the remaining $5,000 to reduce your ordinary income tax by the maximum amount of $3,000 and carry the remaining $2,000 over to the following year.

How to Use ZenLedger to Prepare for Crypto Tax Season

It can be a stressful time when tax season looms. Like any other kind of tax, you would need to be thoroughly prepared with the right materials. Below are the steps to help you get through the crypto tax season.

1. Keep detailed records of all your sources. Understanding how many exchanges and wallets you have used and the wallet address will help immensely when filing your cryptocurrency taxes. 

2. Be as comprehensive as possible when it comes to your crypto transactions between various wallets and exchanges to avoid future penalties and tax liabilities. An exchange will likely provide your cumulative amount traded throughout the fiscal year in Form 1099-K. Other exchanges may also provide information on capital assets in Form 1099-B but neither will give you a complete or holistic view of your crypto taxes. You will want to use ZenLedger to receive comprehensive crypto tax reports. 

3. Calculate your gains and losses as well as your cost basis. To ease this process, it's worth investing in crypto tax software to save time and money as well as helping you to get strategic about your crypto taxes and portfolio throughout the year

4. Fill in Form 8949, which is the specific tax form for reporting crypto capital gains and losses, and add that to Form Schedule D, which is the main tax form. Any cryptocurrency earned as an income needs to be added to Schedule 1 Form 1040, and self-employed earnings from crypto need to be added to Schedule C.

5. Submit the forms and pay any tax owed.

ZenLedger addresses a key pain point for crypto investors by providing an easy solution for crypto tax preparation and portfolio management. With the ongoing tax reporting debate in Congress and the virtual currency question listed at the top of Form 1040, the current administration and the IRS have made it clear that they are taking crypto tax evasion seriously.

ZenLedger aggregates user transaction information across thousands of exchanges, wallets, and tokens into one simple dashboard, making it easy to calculate tax liability and make financial decisions. ZenLedger helps cryptocurrency investors and tax professionals stay compliant with integration support for over 400+ exchanges, 40+ blockchains, 30+ DeFi protocols, NFTs, and all wallets.

Use code “CoinGecko10” to receive 10% off any of ZenLedger DIY Plans.