Trying to figure out and understand your taxes is hard enough. But it gets even more confusing when you try to figure out your tax obligations around cryptocurrency trades and/or ownership. Let’s take a look at what tax obligations you might have if you’ve ever owned or traded in cryptocurrency.
What is Cryptocurrency?
Cryptocurrency (crypto) is a digital form of money, and the IRS considers it a type of digital asset. Common types of crypto include Bitcoin and Ether (also known as Ethereum).
Digital currency has been around for many years. So, what makes crypto different from paying your credit bill online? The primary difference is that, in the online banking example, you’re using money that’s controlled by a central authority (the U.S. Government). In contrast, crypto has no central authority controlling or maintaining it.
The lack of central authority makes crypto attractive. It appeals to individuals seeking anonymity in their financial transactions. Cryptocurrency is, theoretically, more anonymous than regular money. But, taxpayers still have the same tax duties for earnings from crypto.
Tax Obligations with Cryptocurrency
Generally speaking, you’ll have to deal with taxes for your cryptocurrency dealings in three situations. First, it’s when you get paid in crypto. For example, you’re a freelancer or independent contractor and accept payments for your services in crypto. In this case, you’d pay an income tax on these earnings, just like you would if you were paid by check or cash.
Second, you own crypto that’s increased in value when you sell or otherwise dispose of it. For instance, let’s say you bought a single Bitcoin for $10,000 a few years ago. Today, you sell that Bitcoin for $25,000. You’ll have to pay a capital gains tax on that $15,000 increase in the Bitcoin’s value. Here, your tax obligations are very similar to that of a stock you bought low and sold high.
Third, you must answer a question about crypto dealings when completing IRS Form 1040, U.S. Individual Income Tax Return. On the first page, there’s a “Digital Assets” question that asks:
“At any time during 2023, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)? (See instructions.)”
You must answer this truthfully. You have a legal obligation, even if your crypto transaction didn’t result in taxable income. You cannot leave this question blank and must answer “yes” or “no.” You may answer “no” if all you did was buy crypto using real currency (like U.S. dollars). You must not have sold or disposed of it.
This sounds easy, but remember that much of the appeal of cryptocurrency is the ability to do transactions anonymously. As a result, many taxpayers who are trying to hide assets or transactions by using cryptocurrency, will likely answer “no” to this question.
Warning: Lying when answering this question could constitute perjury and/or tax fraud.
When Your Crypto Dealings Don’t Result in Tax Obligations
If you acquire crypto by purchasing it with real currency, you usually don’t have to pay any taxes on it until you sell it or otherwise dispose of it. Also, you don’t pay taxes if you move crypto between “wallets.”
Keep in mind that if you use crypto that’s risen in value to buy something else, you’ll have to pay taxes on that gain. So, let’s say you used U.S. dollars to buy two Bitcoins for $20,000. A few years later, you used those two Bitcoins to buy a small home for $50,000 (at the time of the home purchase, assume Bitcoins were worth $25,000 each). Here, you didn’t technically sell your Bitcoins, but you realized a $30,000 gain in your Bitcoin “investment.” Therefore, you would owe capital gains taxes on that $30,000 appreciation in value.
Still Confused About Crypto and Taxes?
If you’re into crypto and still worry about missing something with your taxes, there are two things you should do. At a minimum, you should keep careful records of your transactions. There are services and tax software options available that can help with this. They may also help calculate any gains or losses that you can report on your taxes.
It’s also a good idea to talk to a tax professional about cryptocurrency tax requirements. The biggest benefit they offer is that they can identify potential problems you might not know about. They can also answer any questions you might have and give you advice on how to reduce your taxes on future cryptocurrency dealings.
Kienitz Tax Law is here to help you with your tax issues. Schedule your FREE consultation today!