And it's normal for investors to have multiple wallets across different exchanges, he said, further adding to reporting challenges. But investors still must disclose their taxable transactions. The best way for high-volume traders to get organized may be investing in tracking software, including versions from previous years, depending on their activity, Markowitz said. While there may be discrepancies, the software may offer an estimate of yearly gains or losses since " If someone expects taxable gains for , they may take advantage of a loophole allowing them to offset some profits with losses.
Currently, digital assets are not subject to the so-called "wash-sale rule," stopping someone from selling a losing investment to write-off the loss against other gains and keeping their exposure by rebuying a "substantially identical" asset within 30 days. However, House Democrats want to close this loophole after Dec. And if someone wants to diversify their regular taxable portfolio, they may use the current crypto wash-sale loophole for the same purpose.
Someone under the threshold may also sell cryptocurrency at a profit, pay no long-term capital gains and rebuy the asset for a so-called "step-up in basis," which adjusts the purchase price to the current value for a lower tax bill in the future. While relying on a tax professional to reconcile hundreds or thousands of crypto transactions may lead to a costly bill, investors may save money by using tracking software to generate reports before meeting with an advisor, Herron said.
However, someone with five, six or seven figures' worth of cryptocurrency may benefit from ongoing tax planning, not just year-end advice, Markowitz said. And like all types of financial planning, the better information investors provide, the more beneficial advice they may receive. Reporting gains and losses is fairly straightforward once you know the ropes, and there are tools to help you if you're not inclined to take on the math and accounting yourself.
Read on to learn everything you need to know about handling cryptocurrency on your state and federal tax returns this year. If you made money from cryptocurrencies in foreign countries, you may also have to pay taxes there. As it has been doing since , the IRS will ask about your cryptocurrency for your taxes. This year the US Individual Income Tax Return form PDF features a question about crypto: "At any time during , did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?
The IRS updated the FAQ page on digital currencies to underline this point, in the answer to a question about taxes: "If your only transactions involving virtual currency during were purchases of virtual currency with real currency, you are not required to answer yes to the Form question. For now, the IRS regards bitcoin and other cryptocurrencies like property. So, if you bought bitcoin and held it all, you don't need to report that on your tax return.
So if you have a taxable transaction, you should be checking 'yes. If you used US dollars to buy crypto on an exchange, or through a private transaction, there's no need to report it. Once you sell, and "realize" a gain or loss, you need to report it -- and pay taxes on any capital gains. In short, they're the difference between how much an asset cost when you bought it and when you sold it.
If the price went up, it's a capital gain. If it went down, it's a capital loss. The IRS has published a longer and much more detailed explanation. The other thing to know about capital gains is that the IRS categorizes them as short-term or long-term. This works both ways. If you lost money on your crypto-shenanigans last year, you can now deduct those losses on your return. The more sophisticated exchanges may have a reporting mechanism to help you collect this kind of information.
Otherwise, unless you've kept detailed records of your own, you may need to root through your email, bank account or wallet receipts. Once you have that information in hand, there are several options available for doing the math. For example, some investors use the "first in, first out" or FIFO methodology, wherein the first coins you buy at what price they cost are also the first coins you sell.
We won't cover all of the methods and math here. You can do a web search to learn more about the options for calculating capital gains. It all goes down on Schedule D , the federal tax form used to report capital gains. Yes, you'll need to report employee earnings to the IRS on a W And if you compensated contractors with crypto, you'll need to issue them a If you sold bitcoin for a gain, it qualifies as a taxable event.
Though the IRS typically dedicates its investigative resources to auditing bigger fish, the outfit is allocating more resources to crypto forensics, and you're better off playing it safe. Section I of the Internal Revenue Code was recently amended as a part of the infrastructure bill. Failure to report transactions of this kind can result in felony charges.
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When you purchase a capital asset — be it a stock, bond, house, widget, Dogecoin , Bitcoin , or other investment — you establish a basis equal to your cost to acquire it. When you sell, you compare your sales proceeds to the basis to determine whether you have a capital loss or a capital gain. If your proceeds exceed your basis, you have a capital gain. If reversed, you have a capital loss. You'll also need to consider the time period for which you held the asset.
Now that you know a bit more about crypto taxes, which is really just another way of saying capital gains taxes, you will want a set of strategies to minimize how much you pay to the IRS. Here are some useful tips to reduce your tax bill. As just noted, different capital gains rates will apply depending on how long you own cryptocurrency.
If you want to lower your tax bill, hold your cryptocurrency long enough to turn your short-term gains into long-term gains. Another strategy for lowering the taxes crypto investors must pay is to offset capital gains with capital losses. This works by subtracting losses on crypto assets that you sold during the year from taxable gains on cryptocurrencies or other investments that have appreciated in value.
Though, be warned: You face limits when using this strategy. When you recognize investment losses, you first must offset losses of the same type. For example, short-term losses first reduce your short-term gains while long-term losses lower your long-term gains. After that, if you have net losses of either type, you can use them to offset the other kind of capital gain.
So, for example, if you have excess short-term losses, you can apply them against any remaining long-term capital gain. If you still have a net capital loss available, you can use it to lower your ordinary income. When waiting for your crypto gains to convert from short- to long-term, you might also consider another timing element: Choosing to sell in a low-income year.
Selling in a low-income year can help with taxes on both short-term and long-term gains. For example, if you sell short-term assets when you retire and are no longer collecting wages, your tax bracket could be based entirely on the income from your short-term gains. If you have long-term capital gains, a lower overall income for the year can mean a lower tax rate on those gains, too.
Also, if you choose to retire early and have accumulated enough cash to fund your living expenses until you can withdraw funds from your retirement accounts, you might have little-to-no-income during the year. Closely related to selling your appreciated investments in a low-income year, another tried-and-true tax minimization strategy involves lowering your taxable income. This means scouring the tax code for tax deductions and credits that can bring your taxable income down.
For example, you can take care of expensive medical procedures, contribute to a traditional IRA or k plan, put money in a health savings account , or donate cash or property to charity. There are plenty of other tax deductions and credits that you may qualify for, too.
You might even want to ask a tax professional to help you uncover some other tax breaks. That way, you either pay taxes later when you conceivably have a lower taxable income in retirement or upfront when you contribute to your Roth SDIRA because you have expectations of higher taxes in retirement. Depending on your goals for using your wealth, you might consider another way of lowering your crypto tax bill: Gifting your cryptocurrency to family members. While the basis in the cryptocurrency transfers to the new owner, the recipient might earn a low enough income where they won't pay taxes on the appreciated property when sold.
Or, at the very least, less in taxes than you might have to pay were you to sell the cryptocurrency yourself. This strategy certainly plays into your broader estate planning goals and how you wish to transfer your wealth. That also makes it something that you should first discuss with an estate planner to ensure that it fits in with your overall plan.
Similar to gifting appreciated crypto to a family member, you might also think about donating your cryptocurrency to charity. Not only will this result in no capital gains tax, it can also trigger a significant tax deduction you can claim on your tax return. When you donate an asset, you can claim the appreciated fair market value at the time of donation as a deduction against your taxable income.
Further, if the charitable organization qualifies as a tax exempt c 3 charity, it won't need to pay capital gains taxes when it sells the donated cryptocurrency later. Forgotten in this article — until now — are state-level income taxes. Not surprisingly, your state has a vested interest in your investment gains as well.
Fortunately, a number of tax-friendly states offer low or no income taxes. That means you might pay taxes at the federal level, but you won't owe much to your state's treasury. If you can, consider moving to a low- or no-income tax state to reduce or even wipe-out taxes on all types of income.
These savings can add up and help you keep more of your crypto-earnings. The final crypto tax minimization strategy on this list is to bequeath your crypto assets as part of your estate. In the United States, any gain or loss generated by Bitcoin is not treated like other forms of foreign currency when it comes to taxation. Like other virtual currencies, Bitcoin officially holds the status of property. This is why in the U. For the taxpayer, this means that Bitcoin is a capital asset and, therefore, is subject to capital gains tax.
In our elaborate Bitcoin Tax Guide below, we will give you an overview of the proper taxation of Bitcoin in the U. Just like with any other cryptocurrency, the sale and exchange of Bitcoin is a taxable event , and, in the US, capital gains tax applies to this. To determine whether a capital gain or loss was realized in the event of a sale, the difference between the fair market value of Bitcoin at the sale and the adjusted basis is calculated.
Example : 1 Bitcoin bought on Coinbase on April For simplification purposes, we assume no other fees incurred. If Bitcoin is exchanged or traded for another cryptocurrency the calculation of a capital gain or loss is based on the difference between the fair market value of the cryptocurrency at the time of the exchange and the adjusted basis of Bitcoin. Ultimately, this means that a net gain or net loss is realized by the sale or exchange of Bitcoin. Depending on how long Bitcoin was held, this is taxed as a short-term capital gain at regular income tax rates or as a long-term capital gain at reduced rates.
To learn more about taxes on cryptocurrencies, read our cryptocurrency taxes guide. As with any other asset, the terms of cost basis and adjusted basis are important for proper tax treatment. The cost basis is the amount of money paid for Bitcoin by the taxpayer. Any additional costs, e. Both the cost basis and the adjusted basis make up the acquisition cost.
In the case of buying Bitcoin, the acquisition cost consists of the price of the Bitcoin at the time of purchase and possible fees, e. In order to calculate the gain on the sale, the selling price less acquisition costs and income-related expenses must be taken into account.
Since most cryptocurrencies are bought at different times, it is important to select an evaluation procedure, which is accepted also by the tax office. Alternatively, specific identification for calculating cost basis might be applied. In the case of exchanging Bitcoin, the capital gain or loss is calculated by the difference between the fair market value of bitcoin on the day of exchange and the adjusted base bitcoin.
Taxpayers must apply a consistent methodology to identify the cost basis for their cryptocurrency and are encouraged to keep detailed records of all exchanges. This means that you should always keep track of your Bitcoin transactions. The cost basis or adjusted basis will be reported on Form and Form , Schedule D.
Realized and Unrealized Bitcoin Gains The realized amount in the sale or Exchange of Bitcoin is determined by the fair market value of the cryptocurrency received by the individual at that time. The fair market value can be determined by converting the amount of Bitcoin into USD at the current exchange rate.
Again, it is always important to keep track of these exchange rates for tax purposes. Just holding Bitcoin or transferring to another exchange or wallet will not be taxable as there is no gain or loss realized. If Bitcoin is sold for cash, the amount realized by the taxpayer is equal to the sale price and any other consideration given to the taxpayer in exchange for the Bitcoin. Similarly, in the event of the exchange of Bitcoin for another cryptocurrency, the amount realized by the taxpayer is equal to the fair market value of the incoming cryptocurrency on the date of the exchange and any other consideration given to the taxpayer in the exchange.
The character of this gain is dependent on the holding period of the original currency in the hands of the taxpayer. Please refer below to the applicable capital gain tax rates to be applied and detailed reporting. Any subsequent sales or exchanges of the cryptocurrency in the hands of the taxpayer will follow capital gain or loss recognition as explained above. The basis of the newly exchanged cryptocurrency is equal to the basis of the amount of Bitcoin it was exchanged for.
The holding period of the new currency in the hands of the taxpayer will begin on the day of the exchange. If Bitcoin was exchanged for another cryptocurrency before January 1st, , this exchange might be treated as a nontaxable like-kind exchange. Although it is still not clear, if like-kind exchange can be applied for Bitcoin and other cryptocurrencies and there is no clear guidance from the IRS, the saving potential is huge, so you might want to check with a qualified tax professional , if you should pursue like-kind exchange.
An important aspect is whether the transaction happened before or after the January 1st, , because of the new tax law that limited like-kind exchange to only real estate. After January 1st, , all exchanges of Bitcoin, just like any other exchange of non-real property, is a taxable event. For both parties involved, the application of the like-kind exchange would mean no gain or loss was realized.
Even though this special type of exchange is tax-free make sure to keep records on when your Bitcoin was exchanged so that you can use it as proof. The holding period of Bitcoin is an important factor for its proper tax treatment. To determine this amount of time, the date of the sale or exchange of the cryptocurrency and the date of its acquisition is taken into consideration. If the taxpayer held the Bitcoin for exactly or less than a year days any realized gain or loss is considered to be short-term.
Likewise, if it was held for longer than a year it is deemed long-term capital gain or loss. The beginning and end dates of the holding period are to be reported on Form Any amount of Bitcoin that was held for less than a year or exactly one year days until it was sold or exchanged is considered a short-term gain or loss and is, therefore, taxed at ordinary income tax rates. Please see the table below for the tax rates for Individual Filers :.
However, due to the fact that Bitcoin was held for longer than a year, these rates come in a reduced percentage. To determine the correct reduced tax rates and calculate long-term capital gains tax appropriately, the taxpayer is highly advised to use the instructions on Form Please see the table below for the preferential long-term capital gain tax rates for individual filers :.
Most cryptocurrencies like Bitcoin are open source projects.