Crypto taxes: Accounting for NFT art, crypto income, Bitcoin holdings and more during the toughest tax year yet
Tax season is here and with it comes a new wrinkle for many investors—navigating the tricky waters of cryptocurrency taxes.
The speed, excitement, and hopes for the chances of making fast cash, has attracted a flood of new crypto investors. In fact, more than a quarter of American investors now hold some Bitcoin and 55% of them began investing in crypto in the last 12 month, according to a study by Grayscale Investments.
As crypto investing becomes more commonplace, it’s also gotten more complicated. Especially as people venture into buying non-fungible tokens (NFTs) and are earning more income from crypto. That’s led to some increasingly complex tax issues and grey areas that haven’t been explicitly spelled out, or yet figured out, by the IRS. And while the pandemic has wreaked havoc on the understaffed IRS, that doesn’t mean they’re not keeping a close eye on crypto.
“A lot of people don’t report crypto thinking that crypto is completely invisible from the regulators like the IRS,” says Shehan Chandrasekera, head of tax strategy at crypto tax firm, CoinTracker.
“In some cases you do receive a 1099 and the IRS already knows, but the IRS also has other ways to know what you’re doing. It’s a big misconception that they can’t follow you on blockchain.”
With that in mind, here’s what you need to know about cryptocurrency and paying taxes.
What triggers cryptocurrency taxes?
If all you did last year was buy crypto with dollars, and let it hang out in your digital wallet, you don’t owe taxes on it. Crypto only becomes taxable when you sell it, spend it, exchange it for another cryptocurrency or get paid with it.
What do you owe when you sell or trade cryptocurrency?
In the eyes of the IRS, crypto isn’t cash, but property. Tax-wise, crypto is treated like other capital assets such as stocks or bonds. And just like with stocks, if you sell crypto for more than you paid for it, you’ll be taxed on the gains.
The important thing to know when you’re buying and selling crypto is how much you paid for the crypto (cost basis) and how much it was worth when you sold it. As an example, if you bought $2,000 in Bitcoin, and you sold it when it was worth $3,500, you’d have to pay capital gains tax on the $1,500 difference and report it on IRS Form 8949.
If you sell your crypto less than 12 months after you bought it, you’ll be taxed at the short-term capital gains rate. These gains are taxed at regular income rates, which range from 10% to 37%, depending on your income. If you hold your crypto for more than a year and then sell, you’ll be taxed the more favorable long-term capital gain. That’s a usually much lower rate of 15% or 20% for high-income earners, Chandrasekera says.
Trading one cryptocurrency for another is also a taxable event. Trading a coin is considered getting rid of it, and if it’s worth more at that moment than what you paid for it, you’ll have to pay capital gains tax.
This is an area where people tend to get in trouble, Chandrasekera says.
“They have the capital gain [from the trade], but they didn’t set aside enough actual cash to pay taxes that year,” he says.
And crypto is inherently an investment that encourages trading. Scores of investors “buy the dip,” aka buy a cryptocurrency when its price drops in the expectation that it will soon bounce back. New investors in particular are drawn to the ease of trading and 24% make trades daily while 33% make them weekly, according to a CNBC survey.
Can you harvest your crypto tax losses?
Absolutely. As with stocks, you’ll need to track both your losses and gains when you sell or trade crypto. You can offset crypto and NFT losses up to $3,000 each year. If you have losses above $3,000, you can carry them forward indefinitely.
What happens when you buy something with crypto?
One of the biggest barriers to crypto giving fiat currency a, well, run for its money, is how it’s taxed. When you spend physical cash, you don’t pay taxes on the cash itself. Not so for crypto. Once you dispose of the crypto, if it’s worth more than what you paid for it, you’ll pay capital gains taxes on it. That’s one area where many investors get tripped up, says Brian Harris, a tax attorney and founding member of tax and litigation firm Fogarty Mueller Harris in Tampa, Florida.
“You have to figure out gain or loss the way you would have any other sale of property even if you use it to buy a pizza or a car,” he says.
As an example, let’s say you bought $10,000 in Bitcoin a few years ago and it’s now worth $50,000. If you use that coin to buy a $40,000 car, you’ll have to report $40,000 as taxable income on your tax return.
What about money you earn in crypto?
Any money you make in crypto, whether it’s payment for a job or from mining crypto, is taxed like ordinary income at your usual tax rate. “You’re basically earning that the same way as if someone paid you in cash,” Harris says.
You’re taxed on the gross amount of the coin’s fair market value the day you received it. Money you earn from mining cryptocurrency or stalking cryptocurrency is treated the same way as ordinary income. With staking cryptocurrency, you “lock up” your crypto in a wallet which triggers software that helps validate transactions on the blockchain. This process is necessary for cryptocurrency like Ethereum that use the proof-of-work method. People who stake their coins then earn a reward similar to the interest that banks pay costumes for keeping money in a savings account.
“Staking has become popular because it’s one of the easiest ways to earn passive income,” Chandrasekera says. “For example, Cosmos is a coin you can stake on Coinbase. You buy the coin, do nothing, and Coinbase credits you annual interest every second and you can see your balance increasing every second.”
There is a chance, though, that how the IRS treats money made from staking could be about to change. The IRS recently refunded taxes to a man who sued the agency over being taxed on new tokens he created through staking. Future IRS policy could see staking rewards taxed not as income, but as capital gains once those coins are sold.
So you’ve jumped into NFT art. What does that mean for your taxes?
The creation of non-fungible tokens (NFTs) exploded in 2021. That was partly fueled by eye-popping events like artist Beeple selling his NFT-based artwork, “Everydays: The First 5000 Days,” for more than $69 million in a Christie’s auction.
“NFTs are like pictures that are created in limited quantities,” Chandrasekera says. These digital certificates show ownership of a unique file stored on a blockchain, typically Ethereum. They might be a digital copy of a piece of art, an autograph or even a GIF.
The tax rules for NFTS are pretty much the same as those for cryptocurrency. Simply buying an NFT doesn’t trigger a tax, but any profit you make from the sale or trade of one can be taxed as capital gains.
It’s important to note, though, that if you hold an NFT for more than a year, “it could be treated as a collectible under the IRS code,” Chandrasekera says. Art-based NFTs, for one, often get classified as collectibles. What that means is that people with a high net worth could be taxed at 28%, which is 8% higher than regular long term crypto gains, Chandrasekera adds.
Should you use a tax advisor who specializes in crypto?
If you’re simply doing a little dabbling in cryptocurrency, you may be able to handle the taxes on your own or with your usual tax professional. That’s especially true if you’ve kept good records on your cost basis and can easily download your transactions from a cryptocurrency exchange.
Crypto-focused software programs like CoinTracker, TokenTax and CryptoTrader can help you keep track of your gains and losses. They’re also usually compatible with regular tax software like TurboTax or TaxAct.
But if you’re trading crypto daily, dealing with large amounts of money, or you’re mining or staking crypto, then you’ll probably want to work with a CPA who is knowledgeable in handling crypto taxes, Chandrasekera says. That’s especially true if you have multiple wallets spread across several cryptocurrency exchanges.
“In the crypto space, it’s really hard to keep records, but the IRS expects you to keep track of it,” he says.
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