$500,000. That's how much a Reddit user claimed they owed the IRS after trading ethereum in 2017. The problem: They didn't realize this until 2018. By then, their account had dropped from $1 million to less than $200,000, and because all the losses occurred in 2018, they couldn't deduct any of it from their $500,000 bill.
While stories like these are scary, most of them could've been prevented with basic crypto tax education. Here, we cover the big picture so you can avoid common crypto tax pitfalls. As always, consult with a tax advisor to accurately manage your tax bill.
Do you have to pay taxes on crypto?
According to Notice 2014-21, the IRS currently considers cryptocurrencies "property" rather than currencies, which means they're treated a lot like traditional investments (such as stocks). Selling at a profit triggers capital gains tax, while selling at a loss may allow you to take deductions.
Unlike stocks, however, there are more tax nuances to consider.
How is crypto taxed?
Crypto can be taxed as capital gains or ordinary income. Here are some of the most common triggers. Note that these lists are not exhaustive, so be sure to speak to a tax professional to ensure accuracy.
- You sold your crypto for a profit. Positions held for a year or less are taxed as short-term capital gains. Positions held for over a year are taxed at lower rates as long-term capital gains.
- You exchanged one cryptocurrency for another. Say you traded bitcoin (BTC) for ethereum (ETH) at a profit. Your taxable gain for this transaction would be the dollar amount you received in ethereum minus the cost basis of your bitcoin (also known as the original purchase price).
- You bought goods or services with crypto. Assume it's 2021, when Tesla was still accepting bitcoin. During this time, you bought a Tesla Model 3 with an amount of bitcoin that has increased in value since your original purchase. Your taxable gain would be the value of your bitcoin at the time you bought the car minus the cost basis of your bitcoin.
Example: You bought $30,000 worth of ethereum (ETH), then traded them for bitcoin (BTC) with a $40,000 fair market value at the time of the trade ("fair market value" is simply how much the coins are worth at the time of the transaction). Taxable gain: $40,000 − $30,000 = $10,000. Two months later, the fair market value of your BTC has risen to $60,000, and you spend all of it on a Tesla Model 3. Taxable gain: $60,000 − $40,000 = $20,000.
Note: if your taxable income is below the minimum threshold for the year, you may qualify for a 0% rate on realized long-term capital gains.
Image is for illustrative purposes only
- Your salary was paid in crypto. This is also taxed based on the fair market value at the time you were paid.
- You received crypto from mining or staking, or as part of an airdrop or hard fork.* If you're self-employed and running a crypto mining business, you'll also need to pay self-employment tax to cover your Medicare and Social Security contributions. Tax treatment for these scenarios is evolving—consult with tax advisor for the best way to file.
- You sold goods or services for crypto. Your revenue is taxed based on the fair market value at the time the transaction was made. If this was a business transaction, your expenses may offset some of your revenue.
- You sold crypto that is classified as "inventory." If you run a business that sells cryptocurrencies (for example, as part of a mining operation), you may trigger ordinary income tax on your sales. For more details, refer to Notice 2014-21 and consult a tax professional.
Example: On September 1, your employer pays you $5,000 in BTC. Your taxable income on this transaction is $5,000, regardless of whether the value of BTC goes on to rise or fall in value.
- You sold your crypto for a loss. You may be able to offset the loss from your realized gains, and deduct up to $3,000 from your taxable income for the year if your losses exceed your gains.
- You exchanged one cryptocurrency for another at a loss. Say you traded BTC for ETH, but the value you received in ETH was less than the cost basis of your BTC. You may be able to deduct the loss.
- You bought goods or services with crypto at a loss. If the goods or service you purchased was worth less in value than the cost basis of your crypto, you may be able to deduct the loss.
Example: You bought BTC at a $70,000 cost basis. Two months later, the fair market value of your BTC position has dropped to $60,000. You use all of it to buy a Tesla. Your loss on this transaction is $70,000 − $60,000 = $10,000. You may be able to offset $10,000 of realized capital gains, or $3,000 of ordinary income.
- Your crypto was stolen or lost. According to current law, these are unfortunately generally not tax-deductible events.
- You bought and held crypto as a passive investor. There is likely no tax owed.
- You paid fees on your crypto purchase or trade. You may be able to add your fees to your cost basis.
- You donated crypto. You may be able to take a deduction based on the fair market value of your crypto at the time of donation. However, note that getting a deduction for charitable donations can be difficult for individuals.
What is the crypto tax rate?
Gains from crypto transactions and crypto classified as income are taxed at the applicable rate depending on a number of factors, including your holding period and capital asset status.
Refer to the applicable tax tables to determine the marginal rate that applies to your situation.
How to calculate crypto gains for taxes
Your brokerage platform or exchange may send a year-end statement detailing your gains and losses. If they don't, one helpful way to calculate your crypto taxes is to use tax preparation software. It's likely the software you use to calculate the rest of your taxes will also support crypto calculations.
To calculate your crypto taxes with tax preparation software, you'll first need the details of your crypto trade or purchase, including cost basis, time and date, and fees. If you bought or traded crypto via an exchange, you'll likely be able to access this data from your account. Most exchanges keep this information readily downloadable as a .csv file, and many tax software programs allow you to directly import your .csv.
Once your data is synced, the tax software will calculate the tax due based on your gains and your total taxable income. Note that calculations aren't guaranteed to be accurate, and you should check all entries in your software against data from your exchange dashboard.
As always, consider working with a licensed tax professional to help reduce the possibility of errors.
How to report cryptocurrency on your taxes
In general, you will report your crypto transactions on the following forms.
- Capital gains are reported on Schedule D (Form 1040). It's likely you'll need to complete Form 8949 first in order to complete Schedule D accurately.
- Gains classified as income are reported on Schedules C and SE if you received them as a self-employed entity.
- Gains classified as income are reported on Schedule 1 if you received them as an employee.
Your exchange may provide a statement you can use to prepare your tax return if you bought or traded through their platform.
The list above is not exhaustive. Consider consulting a licensed tax professional to help accurately manage your tax bill.
Strategies that may help reduce cryptocurrency taxes
Now that you know how crypto can be taxed, here are a few strategies that may help manage your tax bill:
- Hold investments for at least one year and a day before selling. Long-term capital gains are taxed at lower rates than short-term capital gains.
- Consider crypto tax-loss harvesting. That means offsetting your crypto losses against crypto gains or other capital gains to help reduce your tax bill.
- Donate or gift your crypto. Donations could actively reduce your tax bill, while gifting could help you avoid paying taxes on gains. Gifting crypto is generally not taxable unless the value of the crypto exceeds the current year's gift tax exclusion amount at the time of the gift. For example, in 2023, the annual gift tax exclusion is $17,000, so if the value of the crypto gifted is under $17,000, you likely won't incur the gift tax.
- Remember self-employment deductions. If you earn crypto through a self-employed entity, don't forget about potential deductions for legitimate business expenses, including inventory, rental, utility, and even travel costs.
Not all these strategies will be appropriate for your situation, but knowing the basic crypto tax rules may help you keep more of your profits. To avoid any unexpected surprises, always know how your trade will be taxed before you execute. Always consult a tax advisor about your specific situation.
Also, in general, remember that crypto is highly volatile, and may be more susceptible to market manipulation than securities. Crypto holders don't benefit from the same regulatory protections applicable to registered securities, and the future regulatory environment for crypto is currently uncertain. Crypto is not insured by the Federal Deposit Insurance Corporation or the Securities Investor Protection Corporation, meaning you should only buy crypto with an amount you're willing to lose.
*Quick definitions: Think of mining as freelancing. You’re paid in cryptocurrency for your work. Staking is a lot like depositing money in a bank account. The interest you receive is what’s taxed. Airdrops are monetary rewards for being invested in a cryptocurrency. Hard forks happen when a cryptocurrency splits into two versions. As a holder, you typically receive airdrops of the new version.