With bitcoin (BTC) hovering around 45K and the fast-approaching tax season, there has never been a better time to talk about how the IRS taxes your cryptocurrency income.
Cryptocurrencies like bitcoin are treated as property per the IRS Notice 2014-21. You may have to report your cryptocurrency gains and pay taxes on your 2023 tax return if you had any of the following transactions during 2023.
Taxable cryptocurrency transactions
1/ Selling cryptocurrency or Non-fungible token (NFT
NFT) into USD (Cashing out)
This is probably the clearest reportable event for many people.
Say you purchased 1 BTCBTC for $20,000 in January 2023 and sold it for $41,000 in December 2023. Your profit from this transaction is $21,000 ($41,000 – $20,000). This $21,000 is considered short-term capital gains because you only held your coin for less than 12 months. Consequently, $21,000 will be taxed as ordinary income and subject to your income tax bracket which ranges from 10% to 37%.
Alternatively, if you were to sell the BTC after holding it for more than 12 months, the $21,000 profit would be subject to long-term capital gains which offer you more favorable tax rates (0%, 15%, or a maximum of 20%).
2/ Converting one crypto/NFT to another crypto/NFT
This is perhaps the most surprising taxable event for many people.
Say you purchased 1 BTC using 40 ether (ETHETH) valued at $40,000. You purchased this ETH a few years ago for $10,000. During this transaction, a profit of $30,000 ($40,000 – $10,000) will be subject to capital gain taxes. Here, the logic is that by the time you spend 40 ETH to purchase 1 BTC, your wealth has increased by $30,000 due to the appreciation of ETH. This IRS taxes this delta. Receiving cash or not is irrelevant for tax purposes (A16).
3/ Spending cryptocurrency to buy goods or services
Although somewhat uncommon, you can spend cryptocurrency to buy goods and services.
Say you spent 1 BTC to purchase a car during 2023. You spent $10,000 to acquire this BTC a few years ago. At the time you spent this on the car, it was worth $40,000. Here, you have a taxable gain of $30,000 ($40,000 – $10,000) which is subject to capital gains taxes.
4/ Earning cryptocurrency through wages, mining, and staking
You can earn cryptocurrency through various methods such as employment income, mining rewards, and staking rewards. These types of rewards are taxed as ordinary income at the time of receipt based on your tax bracket.
Say you earned 1 BTC as a mining reward. At the time of the receipt, this is worth $30,000. You would be taxed for $30,000 of income based on your ordinary income tax bracket. Say you later sold this coin for $40,000. Here, the delta of $10,000 ($40,000 – $30,000) will be taxed as capital gains.
5/ Receiving cryptocurrency through an airdrop or harfork
Finally, based on IRS Rev. Rul. 2019-24, cryptocurrency received through airdrops and hard forks are taxed at the time of receipt, as ordinary income. It’s quite common to see the coin value going down after you receive the airdrop. Unfortunately, you can not get any tax relief for this unless you sell the coin to claim the loss.
Other complex cryptocurrency-related transactions like wrapping, liquidity pools, initiating loans, and bridging could also result in taxable events depending on the facts and circumstances of each case.
Non-taxable events include hodling cryptocurrency, transferring assets from one wallet/exchange you own to another, donating cryptocurrency to a charity, and sending & receiving cryptocurrency gifts.
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