Taxes are generally difficult to understand. And when you add cryptocurrencies to the equation, it’s easy to become overwhelmed.
However, the good news is that disposals, staking, hard-forks, payments, gifting, and other crypto-related activities, have moved from a general strategy of tax on cryptocurrency to more complex norms.
You might not owe tax on cryptocurrency if all you did last year was buy and hold crypto. It becomes more challenging if you have sold or dabbled in it in the past year. If you have carried out any taxable transaction in 2021, you’ll be required to report any earnings to the IRS during the current tax season, which has already begun.
Meanwhile, as you try to traverse the murky waters of tax on cryptocurrency this tax season, here are six key questions to consider.
- How is Crypto Treated? As Capital Gains or as Income Tax?
Answer: As discussed in the previous answer, cryptocurrencies that are sold are considered capital gains or losses. However, the IRS states that crypto earned from staking or forking is considered as ordinary income. There are some exceptions, such as crypto received as a gift, which may be exempted.
Here’s a list of all the events where you have to pay either capital gains tax or income tax on cryptocurrency transactions:
Crypto Capital Gains
- Purchasing products and services using cryptocurrency
- Cryptocurrency is being sold in return for fiat currency
- Changing one cryptocurrency for another
Crypto Income
- Bonuses earned via DeFi Bounty
- Obtaining cryptocurrency using an airdrop
- Staking and a liquidity pool can be used to earn cryptocurrency.
- Cryptocurrency mining reward
- I Don’t Receive Tax Forms from my Exchange. Do I have to Pay Tax on my Cryptocurrency?
Answer: Yes, you have to pay tax on your cryptocurrency if you have carried out a taxable event. The statement stands true, even if you have not received tax forms from your crypto exchange.
As stated earlier, cryptocurrencies are considered property by the IRS. You must record a gain or loss at the time of selling the property. You must legally record the cryptocurrency transaction if you sell it.
- I bought ETH with BTC. Will it be considered a taxable event?
Answer: If you bought crypto with another, it is a taxable event. When buying ether with bitcoin, for instance, you must theoretically sell your bitcoin before purchasing the new asset. The IRS deems this a taxable transaction because it is a sale. If you sold your bitcoin for more than you bought for it, you’ll owe taxes.
- I received crypto through staking or forking. Will it be considered a taxable event?
Answer: The IRS has stated that if you obtain cryptocurrency as a result of a hard fork, you should consider it as ordinary income depending on the FMV of the cryptocurrency at the time of receiving it.
Unclaimed prizes are a murky area in which you should seek advice from a CPA. Staked awards should likewise be treated as regular income. If you’re staking external to the exchange that records the FMV at the time of possession, third-party applications may be useful.
- Will transferring crypto from one wallet to another wallet be considered a taxable event?
Answer: A lot of cryptocurrency traders have many wallets and frequently transfer funds between them. And, transactions between wallets that you own and manage are tax-free.
Multiple wallets, on the other hand, can generate tax reporting issues since exchanges and wallets lack information and may treat a transaction as a taxable event. Keep meticulous notes as you proceed or white-label wallet addresses to avoid complications.
The Bottom Line
That’s all there is to it when it comes to tax on cryptocurrency.
One cautionary note: Keep records of your activities throughout the fiscal year. That way, you won’t be caught off guard by the tax on cryptocurrency holdings, and you’ll be ready when tax season arrives.
FAQs
- What happens if you don’t report tax on cryptocurrency?
If you don’t record the taxable crypto transactions and are audited by the IRS, you might face penalties, interest, and possibly criminal prosecution. With minimal employees, the chances of IRS inspection are lower, but the agency may pursue greater sums of money.
- When is crypto taxed as income?
Crypto gains are taxed either as income or capital gains. The following events are crypto income tax events:
- Bonuses earned via DeFi Bounty
- Obtaining cryptocurrency using an airdrop
- Staking and a liquidity pool can be used to earn cryptocurrency.
- Cryptocurrency mining reward
- How do you avoid paying taxes on cryptocurrency?
Buying cryptocurrencies inside of an IRA, 401(k), defined benefit, or other retirement plan is the easiest option to delay or eliminate tax on your cryptocurrency assets. If you buy bitcoin in a regular IRA, the profits will not be taxed until you start taking distributions.