Taxation on cryptocurrency trading in the United States was addressed by the Internal Revenue Service in its notice 2014-21. According to the IRS, all cryptocurrencies qualify as assets rather than currency and are, therefore, subject to a capital gains tax when they are traded for profit.
Tax Considerations in Cryptocurrency (Source: BitIRA)
Whether you sell the cryptocurrency directly for money, or you trade it for other cryptocurrencies at a profit or you use it to purchase goods or services, the IRS ruling makes it subject to tax. The IRS also ruled that cryptocurrencies obtained from mining would be classified under income tax rather than capital gains tax. However, if you trade it after a while, you will still be required to pay the capital gains tax.
In 2019, the IRS started including a question on its Form 1040 asking taxpayers to disclose all their cryptocurrency transactions within the tax year.
How Is Cryptocurrency Taxed?
Taxation on cryptocurrency trades works on the popular principle of capital gains tax. If you purchased a cryptocurrency worth $500 but you sold it, after a while, when its value became $2000, the capital gains tax applies to the $1500 profit you realized from the sale.
However, if you bought the cryptocurrency for $1000, and by the time you sold it, its value had decreased to say $200, you would not be required to pay any tax on the sale since you did not make a profit. Instead, you can even use the capital loss you posted from the cryptocurrency trade to offset the tax that is required on your income.
Cryptocurrency taxes also depend on how long you’ve held the asset. If you bought and sold the cryptocurrency within the same year, your profits would be classed under the short-term capital gains. Therefore, you’ll end up paying the normal tax rate.
However, if you hold the cryptocurrency for more than a year before selling it for profit, you will be taxed under the long-term capital gains tax which tends to be generally lower than the regular income tax. Also, if, instead of trading the cryptocurrency for money, you used it to buy a car that is worth more than the original price of the cryptocurrency when you purchased it, you will still be required to pay the capital gains tax.
How To Minimize Cryptocurrency Taxes
There are several legal ways to minimize your cryptocurrency taxes. They include:
- Avoiding Short-Term Capital Gains Tax – If you can hold your cryptocurrency for more than a year before you sell it, then you will benefit from the long-term capital gains tax which is significantly lower than the short-term capital gains tax.
- By Offsetting Your Gains With Your Losses – You can decide to trade your underperforming coins so that the loss you record from them will offset the gains you record from trading other cryptocurrencies.
If you bought Bitcoin for $1000 and sold it for $2000, but you also bought Binance Coin worth $1500 and sold it for $500, you can then offset your gain with your loss and end up paying no tax on the cryptocurrencies.
Frequently Asked Questions
- Am I Required to Pay Tax on My Cryptocurrency If I Received It as a Gift or I Gifted It to Someone Else? – The Internal Revenue Service (IRS) does not require tax on gifts except it exceeds $15,000 in a single year. Therefore, if you give someone cryptocurrency that is worth that amount without receiving anything in return, you will be required to file a gift tax return. Most times, the form only serves to disclose the gift so you may end up not paying the tax itself. The receiver of the gift is not obligated to pay tax on it.
- How Do I Avoid Paying Cryptocurrency Taxes? – You cannot. Since cryptocurrency transactions are easily accessed on a public ledger, it is futile to even try to evade paying taxes for them. There is a good chance that you will be caught sooner or later and then have to pay stiffer penalties.
- Will I Be Taxed If I Am Paid Cryptocurrency for My Services? – When you receive cryptocurrency as payment for your services, you will be taxed as if you earned the equivalent value of that cryptocurrency in fiat. Therefore, it will be classed under personal income tax rather than capital gains tax.
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