Did you join in with the many people who invested in cryptocurrency last year? You may be surprised come tax season if you did. Cryptocurrencies including Ethereum and Bitcoin are taxable income. The IRS looks at cryptocurrencies as “property” when it comes to taxes. That means your virtual currency gets taxed just like any other asset you may own like gold or stocks.
Crypto in 2022
Last year was a huge year for cryptocurrencies. There were many investors who chose to buy-in for the first time in 2021. According to some recent studies, over half of the current Bitcoin investors just started investing over the last year. Throughout 2021, the crypto market hit numerous all-time highs and lows. This caused many investors to experience large gains and losses. Since there are so many new to investing in cryptocurrencies, many people have never had to pay crypto taxes. Most investors will find the process relatively easy. However, the more active you are in the market, the more complicated taxes can become. Here are the things you need to know about reporting activities to the IRS.
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When do Cryptocurrency Trades Need to Be Reported on Tax Returns
When you purchase crypto with dollars
Just spending US dollars on virtual currency, keeping it in the same exchange you made the purchase in, or even transferring it to a personal wallet doesn’t mean you will owe taxes on it. If all you did was use US dollars to purchase virtual currency, you don’t have to report it to the IRS on your taxes.
Trading Crypto
Taxes come into play when crypto is used as a method of exchange. This includes things like selling crypto for US dollars, exchanging one type of cryptocurrency for another (buying Bitcoin or Ethereum), or paying for services or goods with it. Exchanging or selling the investment for another investment is when it becomes a taxable transaction. If you end up doing a lot of trading, and if you are going in and out of various types of cryptocurrencies, every trade is a taxable event. The IRS has its eye on cryptocurrency transactions this year and they are cracking down on any who tries to dodge taxes. You may have been able to get by without reporting it and being taxed in earlier years, but this year you are not likely to get away with it. You may also expect more audits since the IRS is requiring more reporting and forms.
Trading or Minting NFTs
An NFT, or non-fungible token, is created on a blockchain that shows you are the only owner of that single one-of-a-kind digital item. This is true whether your item is a digital sports collectible, or if it’s something crazy like an animated dog with a pop-tart for a body. NFTs are purchased in digital marketplaces. They are also taxed, just like crypto. However, the IRS hasn’t provided any tax guidance on NFTs to date. That can make it a little complicated and confusing to navigate. Tax implications on any specific NFT depend on a couple of things like whether you are an NFT investor or creator, and how much you are interacting with NFTs.
Minting NFTs
If you are minting or creating NFTs, you need to know what is taxable and exactly how they will be taxed. For example, let’s say that you make NFTs as a hobby and spend 0.1 Ethereum to mint an NFT. If you purchased the Ethereum for $100, but by the time you minted the NFT, it was worth $300, your transaction generated $200 in capital gain. You would be subject to long-term or short-term capital gains tax, based on how long you held onto the Ethereum before you used it to mint your NFT. However, if you operate as a professional and you mint NFTs for business purposes, the $100 would be your ordinary income. Just remember that if you are only creating and minting NFTs as a hobbyist, you won’t be eligible for deducting business expenses.
However, as soon as you sell the NFT for crypto, or even exchange it for another NFT, it triggers a taxable event. It is then taxed as income since you either earn or lose money by selling your NFT. Royalties earned for NFTs you create are also taxed as income. Taxes for NFT investing work the same as they work for trading crypto. For tax purposes, art-based NFTs are classified as collectibles. This subjects them to capital gain taxes. When you purchase an NFT with cryptocurrency, you are subject to capital gain taxes. How much you owe depends on how long you held the NFT and whether or not you made a profit. You can claim NFT losses on taxes too. Let’s say the value of Ethereum decreases when you are buying an NFT, you can claim a loss on it.
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Owing Taxes on Cryptocurrency
The IRS classifies virtual currency as property, so its taxable value is based on capital gains or losses. Generally, you’ll just look at how the value of your holdings changed in a given period, whether that is a gain or a loss. Trading or spending cryptocurrency are taxable transactions since you are spending one capital asset to get another asset. The difference between what you spend and how much you earn will be either a capital gain or loss. That is what you report on your tax return. So let’s say that you purchased $100 worth of Bitcoin and you sold it for $500. Your capital gain is $400. However, if the Bitcoin dropped in value during that time, you end up with a capital loss instead. You can deduct up to $3000 from your taxable income if your losses exceed the gains.
Time has a role to play too. If you hold on to a Bitcoin unit for over one year, it most likely qualifies as a long-term capital gain. If you sold it inside of a year, it is considered a short-term gain. These differences affect the applied tax rate. It can also vary based on your overall taxable income.
How to Report Crypto Income
No matter how you earn cryptocurrency, its value in US dollars needs to be recorded when it is received. Its fair market value needs to be reported on your tax return. Whether you mine for new coins received them for various activities, or received the virtual currency as a payment for services rendered. It is also your responsibility to track the value of cryptocurrency. You can find more information on how the IRS expects you to report virtual currency income.
Tracking Activity
The most essential piece of information pertaining to dealing with cryptocurrencies is to keep track of all your activities and keep up with the fair market value throughout your activities. Your records are important whether you are receiving, selling, or exchanging virtual currency. Some exchanges offer Form 1099-B, but most do not. Ultimately, you are solely responsible for tracking and reporting the fair market value of your currency. Beginning in 2023, cryptocurrency exchanges (or brokers) will be required to issue a 1099-B.
Preparing For Tax Season if You Have Cryptocurrencies
Planning ahead is the key to simplifying your taxes for your crypto-related transactions. Essentially, you need to treat it like a business by making sure all the taxes are up to date on a monthly basis. Being proactive about tracking things accurately will simplify the process. If you only make a few transactions, it may be relatively easy to report your crypto earnings using typical tax software. But if you are more serious about it, you may benefit from hiring a tax professional to help.
