A Brief Guide About Taxes on Cryptocurrency
by Arnab Dey Finance 09 March 2022
Bitcoin, the first-ever cryptocurrency, was launched in 2009 as a peer-to-peer cash system. Designed for anonymous transactions, the virtual wallet holding Bitcoin tokens was untraceable.
Eventually, it drew the attention of authorities due to a surge in money laundering by leveraging cryptocurrency. Tax authorities, as well, took notice that this invisible wealth is difficult to track and tax.
Thus, to track crypto transactions and impose taxes on cryptocurrency, the Internal Revenue Services (IRS) issued Notice 2014-2019. Against this backdrop, thousands of cryptocurrencies have entered the market since the introduction of Bitcoin.
Central bankers, regulators, and federal judges continue to debate whether cryptocurrencies should be deemed as a commodity or a currency. Nonetheless, everyone agrees that the profits earned on crypto should be taxed.
The Basics of Taxes on Cryptocurrency
According to the IRS—who sees cryptocurrency as property—if you sell/exchange your crypto for a profit then the profit is taxable as per the capital gains rate. If you use cryptocurrency to buy something, taxes will be calculated on the token’s fair market value in U.S. dollars at the time of transaction.
This means that you need to take stock of your earnings from crypto in the form of capital gains. If you are not filing in the paperwork with the IRS, it can lead you to receive some hard-hitting penalties. Make sure that you are working with the best crypto tax adviser uk to help you deal with all the tax-related work around your crypto investments.
Using Cryptocurrency for Purchases
Let’s say you purchased a Bitcoin for $4,500 in early 2019 and in late February 2022, you used that Bitcoin worth $36,250 to buy a car.
In this scenario, the taxes will be levied on both the buyer and the seller.
- The seller has to report this as gross income based on Bitcoin’s fair market value in USD at the time of the transaction
- The buyer should report the transaction as a capital gain based on the price difference of Bitcoin paid and its value at the time of the transaction
Taxable events related to cryptocurrency
Taxes on cryptocurrency transactions are imposed when the investor/trader does this with its tokens:
- Exchanges their tokens for fiat currency
- Pays for goods or services, such as buying a car with Bitcoin
- Swaps one token for another
- Receives forked or mined tokens
The IRS will not tax you if you:
- Buy crypto with fiat currency
- Donate crypto to a charity or tax-exempt non-profit
- Gift it to a third-party
- Transfer tokens between wallets
1. Selling your Cryptocurrency
Since crypto is considered as property by the IRS, your profits or losses on selling crypto are considered as capital gains and losses. When a trader sells a token for fiat currency, they need to know the cost basis of the coin.
For instance, if you bought Ether at $5,000 and sold it for $7,000 four months later, you have to pay short-term capital gains tax on the $2,00 you earned. If the same transaction took place after buying the token, you’ll have to pay long-term capital gains tax on the gains you made.
2. Mining Cryptocurrency
Taxation on mining works a bit differently when selling tokens. Miners validate the transaction and add blocks to the blockchain. They use their resources to get compensated for it in the form of tokens. These tokens are taxable as business income, but miners can deduct expenses that were included in cryptocurrency mining such as hardware and electricity.
3. Paying for Personal Purchases
Tracking your taxes on cryptocurrency for purchasing goods or services is quite challenging. For instance, if you buy a cup of coffee with a token then you have to track which coin you used, record the cost basis and its value at the time of the transaction.
4. Exchanging Cryptocurrencies
If you swap one token for the other, it can also expose your taxes. For instance, if you buy Ether with BTC, you are selling BTC, so you’ll have to pay taxes on the difference in BTC’s price between its purchase and its exchange with Ether.
The Next Bitcoin
Even though cryptocurrency transactions are not as anonymous as they used to be, there are hoards of tokens available in the market today. While every token is working toward leading the space, investors and traders always look for the next Bitcoin. Below are a few cryptocurrencies that are making waves in the crypto landscape:
1. Solana
In 2021, Solana soared because blockchain technology itself gained a lot of traction. Users are attracted to Solana because of its fast 2,500 transactions per second.
This speed is the result of a proof-of-history consensus protocol, which adds blocks of data with timestamps further streamlining the transaction verification process. Solana is also gaining a lot of ground in the world of NFTs, a special type of cryptographic token that represents a unique asset
2. Fantom
A blockchain network always faces a trilemma of achieving speed, security, and decentralization. Either one of the aspects has to be sacrificed to gain the other two.
Fantom solves the trilemma with its asynchronous consensus mechanism, which allows validators to verify blocks at various times. With the protocol, anyone can join or leave the network anytime and all validators are considered equal. The transactions are confirmed in one second and cost less than one cent. Today, more than 80 decentralized applications function on the Fantom blockchain.
3. Avalanche
Avalanche is another blockchain known for its fast transaction speeds. It can process 4,500 transactions in a second and each transaction reaches finality in less than two seconds. The reason behind Avalanche’s speed is the structure of its blockchain.
It has three chains: the X chain, the P chain, and the C chain. The X chain enables asset exchange, the P chain systemizes validators, and the C chain is for smart contracts. Due to these three chains, the network is congestion-free unlike other blockchains with one main network.
Final Word
Today, due to the diligence of the IRS, taxes on cryptocurrencies are inevitable. If you are a frequent trader, you should keep a record of all your transactions for your convenience and must report your taxes on time to avoid tax evasion charges. It is highly recommended that you work with a tax professional who is experienced in the tax code of virtual currencies.
FAQs
1. Do you pay taxes on cryptocurrency?
Yes, all cryptocurrencies are taxable as the IRS sees them as property rather than a currency. This means that cryptocurrencies are taxed the same as any asset you own.
2. Do I have to pay taxes every time I sell cryptocurrency?
The IRS considers crypto as a property which means if you receive a token as payment then you have to pay taxes on its fair market value in USD. However, if you sell your virtual currency for a profit then you have to pay taxes on the difference between your purchase price and sales price.
3. Does Coinbase report to the IRS?
Yes, Coinbase reports to the IRS. The exchange sends the Form 1099-MISC to the IRS alerting them that a trader has earned more than $600 worth of crypto rewards. Following this, you have to report crypto taxes for the financial year.
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