Cryptocurrencies like Bitcoin and Ethereum have become extremely popular, but with their rise, the tax implications have also become more complicated. The IRS is paying close attention to cryptocurrency activities, so it’s important to understand how crypto transactions are taxed to stay on the right side of the law. Here’s a simple guide to help you navigate the complexities of crypto taxes.

The IRS Is Watching

When you file your taxes, Form 1040 will ask if you received, sold, sent, exchanged, gifted, or otherwise disposed of any digital assets during the year. Answer this question truthfully. Lying can lead to serious legal trouble.

You don’t need to answer “yes” if you only bought cryptocurrency with regular money or transferred it between your wallets. But if you sold, traded, or used cryptocurrency, you must disclose it.

No 1099? You Still Owe Taxes

With regular investments like stocks, you get a Form 1099 that tells you how much income you earned. This might not happen with cryptocurrencies. Even if you don’t get a 1099 from a crypto exchange, you still have to report your gains and losses on your tax return. The IRS is increasing its scrutiny, so it’s best to report everything accurately.

Using Cryptocurrency Can Create Tax Liabilities

Every time you use cryptocurrency to buy something or exchange it for regular money, you might owe taxes. This happens if the value you receive is more than what you paid for the cryptocurrency. For example, if you bought Bitcoin for $10,000 and later used it to buy a car worth $15,000, you’ve made a $5,000 gain, which is taxable.

On the other hand, if the value you receive is less than what you paid, you can claim a loss. Keeping track of how much you paid (your cost basis) and the value at the time of the transaction is essential.

Trading Gains

Profits from trading cryptocurrency are treated like profits from stocks. If you hold the cryptocurrency for less than a year before selling, you pay taxes at your regular income tax rate, which can be up to 37%. If you hold it for more than a year, you benefit from lower tax rates of 0%, 15%, or 20%.

You can also offset your gains with losses. If you lost money on some trades, you can deduct those losses from your gains, up to $3,000 per year. Any excess losses can be carried forward to future years.

Mining Cryptocurrencies

If you mine cryptocurrencies, the tax treatment depends on whether it’s a business or a hobby. If it’s a business, you can deduct related expenses like electricity and equipment costs from your income. Your revenue is the fair market value of the cryptocurrency when it’s mined.

However, if it’s a hobby, you can’t deduct these expenses. This distinction affects your ability to reduce your taxable income.

Gifting Cryptocurrency

Gifting cryptocurrency follows the same rules as gifting other assets. If the value of the gift exceeds $17,000 in 2023 or $18,000 in 2024, it may be subject to gift tax. The recipient’s cost basis is the same as the giver’s. You can avoid the gift tax by using the lifetime gift tax exemption, which covers significant amounts.

Inherited Cryptocurrency

Inherited cryptocurrency is treated like other inherited assets. It may be subject to estate tax if the estate’s value exceeds certain thresholds ($12.92 million in 2023 and $13.61 million in 2024). Beneficiaries get a stepped-up basis, meaning the cost basis is the fair market value on the date of the decedent’s death, which can reduce capital gains tax when the asset is sold.

The Wash-Sale Rule and Cryptocurrency

The wash-sale rule, which prevents you from claiming a loss if you repurchase the same asset within 30 days, doesn’t currently apply to cryptocurrencies. This allows you to sell at a loss, repurchase immediately, and still claim the loss. However, this loophole might not last, so keep an eye on potential changes.

Conclusion

Handling cryptocurrencies can be complicated and requires careful record-keeping. The IRS is focusing more on cryptocurrency enforcement, so it’s crucial to report all transactions accurately and understand the tax implications.

Cryptocurrencies offer exciting opportunities, but they also come with significant tax responsibilities. By understanding the tax rules and maintaining diligent records, you can enjoy the benefits of cryptocurrency while staying on the right side of the law.