What to know about the IRS rules for bitcoin, ethereum and other cryptocurrencies for the 2023 tax season

What to know about the IRS rules for bitcoin, ethereum and other cryptocurrencies for the 2023 tax season

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  • Cryptocurrency is taxed as property by the IRS, like stocks or real estate.
  • Every time a crypto transaction occurs, capital gains tax is triggered.
  • Investors must track their transactions and calculate their tax obligations.

While many, if not most, cryptocurrency transactions are publicly visible on blockchain networks, there is another entity that has a stake in your crypto holdings: the Internal Revenue Service.

As crypto has become increasingly popular, the IRS has become interested in keeping taxpayers honest about their crypto-trading activity and digital assets. Crypto traders have tax obligations when it comes to their holdings, whether it’s bitcoin, Ethereum, or even Dogecoin.

But many people involved in crypto may still not understand the ins and outs of the taxes involved and how to report everything to the government.

Do you pay taxes on crypto?

The most important thing investors should know is that crypto (or “digital assets,” as the IRS calls them) is considered property and taxed as such.

This ownership distinction is extremely important, says Joe Howe, head of crypto tax at Crypto Tax Girl, a firm that specializes in helping crypto investors. Like stocks or real estate, it’s easy to trigger a taxable event, he says. When there is a gain, you may have to pay taxes. If there is a loss, you may be able to undo it.

“Every transaction made with crypto is a taxable event, outside of buying crypto with fiat currency, like the US dollar,” Howe explains. “The actual purchase is not a taxable event, but if you sell a coin for another coin, then you will have to pay taxes. If you spend the crypto on goods or services, that is also a taxable event – ​​l “One of the drawbacks of the current guidelines is that any crypto expenditure is a taxable event,” he says.

How much tax do you pay on crypto earnings?

Capital gains tax is a tax on profits derived from the sale of an asset or investment, including crypto.

“It works exactly the same as selling stocks,” says Clinton Donnelly, president and founder of CryptoTaxAudit, a tax firm that works exclusively with crypto traders and defends people during IRS audits.

What’s unique about crypto is that capital gains taxes not only apply when you sell, says Donnelly, but also when you pay for something. When you buy something and pay for it using cryptocurrency, it’s a capital gain event since you’ve “effectively sold” the crypto by doing so, he says.

Capital gains taxes are partly determined by how long an asset is held. It is considered short-term if held for less than a year. Otherwise, it’s a long-term gain. Short-term rates correspond to an individual’s ordinary tax bracket, which can be as high as 37%. Long-term rates also depend on an individual’s filing status and taxable income, but generally cap at 20%.

Additionally, investors should be aware that they are taxed on net capital gains, ie the difference between gains and losses.

So if you were to realize a capital gain of $100 on one sale, but a capital loss of $95 on another sale in the same tax year, you would not have to pay tax on the capital gains. principal than on the net gain of $5. The tax rate, again, will depend on how long you have held the asset, your income and your filing status.

This table breaks down the long-term capital gains rates for each filing status:

How to avoid the cryptocurrency tax?

If you’re hoping to avoid crypto taxes, there’s not much you can do but stick to a buy-and-hold strategy.

This is because only crypto transactions trigger taxable events – if you simply keep your crypto assets (and avoid buying goods and services) there is no event to tax. “If you want to avoid taxes on crypto, don’t sell it,” says Donnelly.

Howe says you can also use a tax-deferred retirement account to avoid crypto taxes. “The best way to avoid taxes is to create a self-directed IRA and buy crypto through it,” he says. “It’s a bit difficult, but it’s an option for people.”

Most states have yet to issue guidelines on how gains from cryptocurrency transactions are taxed, so you likely won’t have to pay state taxes.

Cryptocurrency tax reporting

The IRS asks blank on Form 1040: “Have you received, sold, traded, or otherwise disposed of a financial interest in virtual currency?”

If you check “yes”, then you will need to complete Form 8949 to calculate your capital gains or losses. While some major crypto exchanges such as Coinbase and Kraken send investors transaction information to help them complete their tax returns, investors who trade and operate largely on their own through many exchanges or decentralized exchanges will have to follow the transactions themselves.

“We highly recommend that you keep crypto tax software to keep things organized,” says Howe. “Most people have thousands of trades, and it can be risky trying to settle them all.” The Howe team recommends platforms such as CoinTracking, Koinly or CoinLedger as starting points.

All of this may require some legwork. But experts say it is important to take crypto tax reporting seriously. Investors should be honest about their holdings and activities.

“It’s a yes or no question,” says Donnelly, and “if you say ‘no’ and you mean ‘yes’, it turns your tax return into a fraudulent return.”

The IRS has been relatively easy for crypto investors, Donnelly adds. But that is changing.

“The IRS hasn’t been as aggressive as it could have been, but we’re going to see a new IRS in the years to come,” he says.

The bottom line

The most important things for investors to keep in mind are that crypto is currently taxed as property – like stocks or real estate – and any trades will trigger capital gains tax if you trade in a traditional brokerage account.

Long-term capital gains tax rates apply to profits you make on a crypto investment held for more than a year, while short-term capital gains tax rates apply apply to profits on an investment held for less than one year. Ultimately, you may not owe tax if you have investment losses that you can use to offset your gains, but you still have to report everything.

And if you’ve been lax in reporting crypto profits in the past, it’s time to be upfront. “My advice is to start being compliant now and go back and correct your previous statements,” says Donnelly.

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