What is cryptocurrency? And what does it mean for your taxes?
While cryptocurrency has been around for more than a decade, it has soared in popularity in the last year or so. Even if you recently invested in crypto, you may still be wondering, “what is cryptocurrency exactly?”
Whether you’ve purchased crypto to diversify your portfolio, or you just wanted to explore this newer investment type, it’s smart to have a foundational understanding of what you’re investing in. What’s more, you’ll want to know a few key details about cryptocurrency taxes—before tax time arrives.
In this post, we’ll cover what cryptocurrency is, the basics and what you need to know about cryptocurrency taxes, including a breakout of your tax considerations by transaction type.
What is cryptocurrency and how does it work?
A cryptocurrency is a digital or virtual currency that exists on multiple computer systems worldwide. Cryptocurrencies have no central storage, nor are they issued by any central authority—setting them apart from other investment types. For some, that’s the appeal of buying into crypto.
This decentralization brings to light a few key aspects of virtual currency. For one, cryptocurrencies are designed to be tamperproof by use of cryptography, which encodes transaction information between parties.
Here’s how cryptocurrency works
Transactions are generally tracked on a platform called the “blockchain.” That leads us to a couple of terms that will be important for tax purposes:
- On-chain transactions are transactions stored on the blockchain.
- Off-chain transactions are not stored on the blockchain
Some examples of cryptocurrencies are: Bitcoin, Litecoin, Ethereum, and Dogecoin to name a few.
How does cryptocurrency gain value?
Simply stated it is a matter of supply and demand. As demand increases, the value of that currency will also increase. By contrast, if demand falls, the value will also decrease.
That said, the value of your personal holdings can go up and down as supply and demand shift.
How do cryptocurrency transaction fees play into it?
While it’s not likely to be your primary driver for your investment decisions, you should keep in mind that fees—and taxes—may have an impact to your bottom line. The type of fees you pay will vary from one type of currency to another.
And the tax implications? Well, that’s where you can rely on H&R Block to explain the essentials you should know about. Let’s jump into it!
Need help filing your cryptocurrency taxes? No matter if you work with an H&R Block tax pro or use H&R Block Online Premium, we’re here for you!
Like other assets, investing in cryptocurrency comes with tax obligations. But, as we’ve mentioned above, crypto has unique features that makes it stand apart from other investment types. You could say that cryptocurrency taxes follow their own beat.
Cryptocurrency vs. stocks
Sometimes it’s easier to see what something is by comparing to what it’s not. Take stock assets for instance. Review the table below to understand the key tax differences between cryptocurrency vs. stocks for individuals under current U.S. tax law.
|Tax rate||Taxed as either a short-term or long-term capital gain depending on the holding period||Variable – can be taxed as a capital asset (investment) or wages (services received). |
See the next section.
|Taxpayer reporting requirements||Only required to report upon selling||Several activities require reporting beyond selling crypto. |
See the next section.
|Tax forms||Investment firms must report shares sold on Form 1099-B to the IRS and the taxpayer||Some exchanges may issue Forms 1099-K or 1099-B.*|
How is cryptocurrency taxed?
If ever there were a time to say, “it depends”—this is it. Below we break out the following scenarios: buying, exchanging, gifting, getting paid with cryptocurrency and selling it.
Before we begin, we should define a couple of terms:
- Basis – The amount of investment in a particular property.
- Long-term vs. short-term capital gains – When you sell a capital asset for more than you purchased it, it’s called a capital gain. The type of gain is determined by how long you hold that asset. Short-term is under one year; long-term is over one year.
There are no tax implications for buying crypto. However, for your records, you’ll want to know your purchase price to avoid paying unnecessary taxes down the line. Here’s where on-chain and off-chain transactions matter.
If you purchase cryptocurrency in an:
- on-chain transaction, the exchange will value it in U.S. dollars as of the time and day the transaction takes place based on the amount recorded on the block chain.
- off-chain transaction, you must determine the fair market value at the time and date the transaction occurred as if it were recorded on the blockchain. You can use a cryptocurrency or blockchain explorer to determine this value, and it will be accepted by the IRS.
Don’t know the published value? You’ll need to use the fair market value of the property or services exchanged to determine the value of the crypto you received.
Any cryptocurrency transaction fees you pay at the time of purchase can be added to your cost basis. When you eventually sell your crypto, this will reduce your taxable gain by the same amount (ultimately reducing the capital gains tax you pay).
Exchanging crypto for property
If you exchange property for cryptocurrency, you’ll have immediate tax consequences in that tax year. You must subtract the fair market value of the property received from you the basis of the crypto you exchanged. This will show you if you have a capital gain or loss.
Here’s an example:
- Anjali pays $10,000 for cryptocurrency and holds it for 10 months as it grows in value.
- She then exchanges $12,000 of her cryptocurrency to pay for a piece of land (unimproved land for tax purposes).
- The difference between $12,000 (the exchange price) and $10,000 (her basis) is a $2,000 short-term capital gain (It’s a short-term capital because it’s under one-year).
Exchanging crypto for goods/services
If you exchange cryptocurrency for goods or services, you’ll be taxed on the fair market value of the full amount of cryptocurrency as if it were ordinary income.
Here’s an example:
Zach pays Elias to fix a computer for $50 worth of cryptocurrency. Elias does not own a computer repair business.
- Elias will recognize $50 of ordinary income for the cryptocurrency he received.
- Zach purchased the cryptocurrency he paid to Elias for $20 as an investment four years back. Zach will recognize $30 of long-term capital gain.
Note: Self-employed taxpayers will need to pay self-employment tax on the amount of cryptocurrency received for goods/services in addition to treating the amount as ordinary income.
If you receive cryptocurrency as a gift, you won’t have any immediate income tax consequences. You may also have the same basis and holding period as the person who gave it to you. Crypto gifts can be subject to gift tax and generation skipping tax if the value is above the annual and lifetime exclusion amounts.
Getting paid with crypto
Are you receiving your wages in cryptocurrency? Your employer should treat the fair market value of the crypto you receive similar to other wages. That is, it will be subject to Social Security tax, Medicare tax, Federal Unemployment Tax Act taxes, and federal income tax withholding. Depending on your state, the amount may also be subject to state tax rules.
When you sell your cryptocurrency, you’ll owe taxes on any capital gains that result from the sale. As mentioned above, a capital gain is when you sell an asset for more than you purchased it.
You may be wondering if cryptocurrency fees are tax deductible. While there’s not a specific deduction, any cryptocurrency transaction fees you pay when you sell can be subtracted from your proceed amount.
Here’s an example:
- Carolina pays $15,000 for cryptocurrency and holds it for two-years as it grows in value.
- She then sells $17,000 of her cryptocurrency and has fees of $500. She can subtract the fees from her proceeds ($16,500)
- The difference between $16,500 and $15,000 (her basis) is a $1,500 long-term capital gain (It’s a long-term capital because it’s over one-year).
What is the tax rate on cryptocurrency?
The cryptocurrency tax rate is between 0% and 37% depending on how long you held the currency and under what circumstances you received your cryptocurrency.
- Ordinary income rates are between 10% and 37% depending on your income tax bracket.
- Short-term capital gain rates are between 10% and 37% depending on your income tax bracket.
- Long-term capital gain rates are between 0% and 20% depending on where your income level is in a special bracket for long-term capital gains.
Review details for your income tax bracket and rates.
How does the Infrastructure Investment and Jobs Act affect cryptocurrency taxes?
In late 2021, the Infrastructure Investment and Jobs Act became law and changed tax reporting requirements for cryptocurrency.
Based on the new rules, exchanges will be required to send a tax form to report the sale of cryptocurrencies to the IRS and to the taxpayer. The date that the new rule will go into effect has been delayed. As we learn more, we’ll provide additional details
To see how this reporting works now, check out the next section.
Tax form for cryptocurrency
There are two types of tax forms you may encounter for your taxes.
Tax forms sent to you:
- Forms 1099: Depending on your activity and the exchange you use, you may receive either Form 1099-K or Form 1099-B to report your crypto transactions.
- Forms 1099-NEC: You may receive Form 1099-NEC if you are an independent contractor paid in cryptocurrency for performing services.
- Forms W-2: If your employer pays you in a cryptocurrency, you will receive a Form W-2.
Tax forms you must complete:
- Form 8949: You may need to complete Form 8949 to report any capital gains or losses. Be sure to use information from the Form 1099-B you received. If you receive a Form 1099-K, be sure to report both your basis and your gains and losses for your cryptocurrency transactions on Form 8949.
- Form 1040:
- If you did have capital gains or losses, you’ll also record them on your Form 1040/Schedule D.
- If you received wages in cryptocurrency, you’ll record that amount as wages on your 1040.
- If you were paid for services in cryptocurrency, you’ll record that amount as either other income on Sch 1 or income on Schedule C.
- Additionally, a checkbox on Form 1040 will require you to state yes or no to the following question: “At any time during 2021, did you receive, sell, send, exchange, or otherwise acquire any financial interest in virtual currency?”
Reporting cryptocurrency on taxes: How H&R Block can help
Sound complicated? It can be, but that’s why we’re here.
Working with an H&R Block tax pro: Our tax pros speak the tricky language of taxes and can help you determine how to report information regarding your cryptocurrency. Find an H&R Block tax pro.
Filing your taxes on your own? If you’re using H&R Block Online Premium, we’ll walk you through what you need to know. If you get stuck, help is just a few clicks away with our Online Assist options.
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