Navigating the Complexities of Cryptocurrency Taxes – What You Need to Know

Taxes related to cryptocurrency investment and trading have become an increasing burden for investors and traders, so staying abreast of all relevant regulations and reporting requirements is essential for maintaining compliance and optimizing investment strategies.

Gains on cryptocurrency transactions are subject to tax in the same manner as gains on any other investment or property, with losses harvested offsetting gains to help lower overall tax liability.

Capital Gains

As the IRS views cryptocurrencies as property, any time one is sold or exchanged for something of value (like another cryptocurrency or cash) or used to earn income via mining or staking on a blockchain it triggers tax events and potential gains or losses may arise depending on its market price at time of sale.

If the cryptocurrency was purchased at less than its current trading price, any discrepancies are considered capital losses which can be claimed on tax returns to offset gains and reduce overall tax obligations.

Advisors must explain these tax nuances to their clients so they understand what is expected of them and any surprises down the road. For instance, if someone trades bitcoin for ethereum at a profit, their taxable amount would equal the difference in current market prices plus their cost basis from when they initially bought bitcoin.

Losses

the public has become more worried than ever about the security of digital assets due to recent crypto exchange and platform collapses and high-profile thefts, prompting swift regulatory change. Tax professionals must stay current on these changes so as to offer guidance that is up-to-date and accurate for their clients.

As with any asset sale, cryptocurrency investors must pay taxes when their cryptocurrency sells for more than what was paid initially (known as “basis”). Your tax rate depends on whether the profit was long or short-term and how long you held onto the asset for.

Conversely, crypto investors may experience losses when spending their cryptocurrency. Typically, these are treated like stock losses in that you must have experienced a taxable event in order to realize that its value has declined and be eligible to claim your deductions.

Tax Rates

Tax rates determine how much a person owes the government for any realized capital gain they experience, with rates typically depending upon both an individual’s tax bracket and how long they held onto cryptocurrency for.

Example 1 illustrates this point clearly. Assume you purchased crypto for $1,000 and spent it over time on lunches and coffee purchases – if the total exceeds your original purchase price then this amounts to a capital gain. Likewise if mining crypto as a business you may be eligible to claim some expenses against income.

Cryptocurrency taxes possess distinct features that distinguish them from other investment types, so understanding its regulations is paramount to maintaining an honest legal record and optimizing investment strategies. Advisors can assist clients avoid unwitting tax evasion, which can incur serious legal and financial consequences, while keeping in mind that cryptocurrency regulations are constantly shifting.

Specific Identification

As with all financial transactions, cryptocurrency sales and purchases must be reported to the IRS for reporting purposes. Failure to do so could result in penalties and interest being applied on unpaid taxes.

The IRS mandates meticulous recordkeeping of crypto acquisitions and dispositions, such as dates, amounts, assets, costs, fees and sales proceeds for each transaction. This can be particularly difficult with regards to crypto held on centralized exchanges which impose stringent “know your customer” rules as well as potential withholding taxes.

Tax authorities can track users through various methods, including subpoenaing cryptocurrency exchanges and data analytics tools. As such, crypto holders need to carefully select and select their cost basis accounting method of choice in order to avoid audits from tax authorities and maintain accuracy and consistency with regard to cost basis accounting methods used. Changing between them could confuse IRS auditors; using just one approach eliminates confusion while increasing accuracy.