U.S. taxpayers are required to report cryptocurrency sales, trades, payments, and income to the IRS. But with cryptocurrency still relatively new to being a mainstream part of personal finance, you may be wondering if or how it’s going to affect your tax return. Understanding how to report your digital assets remains complex, but below we’ve created a guide to what’s taxable, what’s not, and what to take note of as you prepare to file your 2024 tax return.
What is a “digital asset”?
The IRS defines cryptocurrency as “digital assets,” and states, “A digital asset is a digital representation of value that is recorded on a cryptographically secured, distributed ledger or any similar technology.” Although not an exhaustive list, they convertible virtual currency and cryptocurrency, stablecoins, and non-fungible tokens (NFTs) are examples of digital assets.
The IRS requires taxpayers to answer the question on their federal return indicating if they received, sold, or exchanged digital assets in the year you’re filing. If you did, it’s possible you’ll be taxed on this event.
How is a digital asset taxed?
Cryptocurrency transactions are taxable in two different categories: as income and as capital gains. How it’s categorized is determined both by how you received the cryptocurrency and how long you held onto it before selling.
Simply put, the current U.S. laws state that all income is taxable—even cryptocurrency. Essentially, the tax rules applied to transactions involving any other asset are the same when applied to crypto. Therefore, if you receive cryptocurrency as payment for services, goods, or employment, it’s considered ordinary income and is taxable the same as if you had received cash as payment. Practices like mining crypto and staking holdings to earn a reward, or even receiving crypto as part of an incentive or reward of some kind, count as earning taxable income.
However, if you bought crypto without transferring, selling, or otherwise using it, it does not qualify as a taxable event. Similarly, gifting cryptocurrency under the annual exclusion limit or transferring between wallets is not taxed.
When are capital gains taxed on cryptocurrency?
For tax purposes, the IRS treats crypto as property. If they are used as payment or cashed in, a taxable event occurs. And when you realize a gain on that sale, exchange, or use of crypto, you will owe taxes on it.
If you hold the cryptocurrency for one year or less before selling, you'll realize short-term capital gains, which is taxed at ordinary income rates. Holding for more than a year qualifies you for the lower long-term capital gains tax rates.
Therefore, the following are examples of taxable events where you could owe tax:
- Selling cryptocurrency for cash. If you sell your cryptocurrency for dollars, this transaction is taxable similar to how a stock or bond would be taxed. For example, if you bought 1 Bitcoin for $5,000 and sold it for $10,000, you have a taxable gain of $5,000. However, if you sell as a loss, you may be able to deduct that loss on your tax return, subject to certain limitations.
- Trading one cryptocurrency for another. If you exchange one cryptocurrency for another, this is also a taxable event, and you’ll owe taxes if you sold your crypto for more than you paid for it. For example, trading 1 Ethereum worth $2,000 for 0.5 Litecoin can trigger capital gains or losses based on the fair market value of the Ethereum at the time of the trade and the difference of the original purchase price.
- Spending cryptocurrency on goods and services. The way the IRS views spending crypto is essentially the same as selling it as you’ll need to sell an asset before it can be exchanged for a good or service. Therefore, no matter what you pay for using crypto, it is subject to capital gains tax.
What forms do you have to use?
When reporting cryptocurrency on your tax return, the key forms you will use are:
- Form 1040: Report your overall income, including any crypto received as payment.
- Schedule D and Form 8949: Use these to report capital gains and losses from the sale or exchange of your cryptocurrencies. Here, you’ll list each transaction, including the date acquired, date sold, proceeds, cost basis, and gain or loss.
Keep track of your crypto transactions throughout the year
Maintaining detailed records of your cryptocurrency transactions is essential for accurate reporting. Because a large range of transactions are considered taxable, it’s important to keep detailed notes on your portfolio. Here are some effective strategies:
- Maintain a spreadsheet—or pay for a service. These days, there are paid services that will keep historic data of your crypto transactions and generate gain/loss reports. Although it’s still important to verify all information before you file, it requires less manual entry.
However, if you prefer manual tracking, create a spreadsheet to log each transaction. Include the date, transaction type (buy, sell, trade), amount, the proceeds/sale price, the basis/original purchase price, and fees paid. Make sure to keep track of your cost basis, the original value of your cryptocurrency investment including purchase price and any transaction fees. Accurately tracking this information is crucial for determining your taxable gains or losses.
- Keep exchange records. Save all records from exchanges and wallets, including transaction histories and any tax documents they provide.
- Update your records regularly. To avoid a year-end scramble, aim for monthly tracking to stay organized.
Reporting cryptocurrency on your tax return can be straightforward, but if you are ever uncertain, it’s important to check in with your tax advisor. By recognizing which transactions are taxable, keeping complete and accurate records throughout the year, and keeping your tax advisor up-to-date on any gains, you can avoid any unexpected tax bills or unwanted IRS attention.