Digital assets have become a widely recognized component of today’s financial landscape. As many major banks now offer crypto products and more merchants accept digital assets as payment, regulatory scrutiny of cryptocurrency has intensified. If you are a cryptocurrency investor or trader, it’s essential to understand the tax implications of your digital assets to remain compliant with the tax laws and optimize your financial outcome.
The following are several tax considerations cryptocurrency investors and traders should keep in mind:
1. Cryptocurrency is Treated as Taxable Property by the IRS
The IRS treats cryptocurrency as property, rather than currency, for federal income tax purposes. As a result, many of the same tax principles that apply to stocks and other capital assets also apply to digital assets, including rules governing cost basis, fair market value, and the recognition of gain or loss. Due to this classification, taxable events occur when cryptocurrency is sold, exchanged, or otherwise disposed of just like a security. Critically, even routine activity, such as making purchases or trading one token for another, can trigger reporting obligations.
2. Cryptocurrency is Subject to Capital Gains Tax
Capital gains tax is one of the most important tax considerations for cryptocurrency investors and traders. Specifically, capital gains or losses are recognized whenever cryptocurrency is disposed of. They are calculated based on the difference between the asset’s cost basis and its fair market value at the time of disposition.
Short-term capital gains generally apply to digital assets held for one year or less and are taxed at ordinary income tax rates. In contrast, long-term capital gains apply when cryptocurrency is held for more than one year before selling. These gains are taxed at reduced rates, which are typically more favorable to the taxpayer. It’s crucial to strategically plan the timing of cryptocurrency dispositions to achieve optimal tax outcomes.
3. The IRS Taxes Certain Crypto Activities as Ordinary Income
Specific crypto activities generate income, rather than capital gains. The IRS taxes the following as ordinary income:
- Mining rewards: The fair market value of coins earned through mining is taxed as ordinary income.
- Staking rewards: Cryptocurrency earned through proof-of-stake protocols is subject to tax when received.
- Airdrops and hard forks: New tokens received from airdrops or hard forks are treated as ordinary income by the IRS once the recipient takes control of them.
- Payment for goods and services: Payment made in cryptocurrency for goods or services is treated as compensation or business income.
Traders operating a business should also be mindful that these activities may give rise to self-employment tax obligations and other business-related responsibilities.
4. Investors and Traders Must Maintain Accurate Records of Every Transaction
For tax purposes, cryptocurrency investors and traders are required to maintain detailed records for every transaction. The records must include the date of each acquisition and disposition, the cost basis, the fair market value at the time of the transaction, and any associated fees. While activity may span multiple exchanges, wallets, and platforms, keeping accurate records can be challenging. Complexities can also arise regarding valuation due to the volatility of digital assets.
Without detailed records, capital gains and losses cannot be accurately calculated, which can lead to overpayment or underpayment of taxes. Inaccurate reporting can also lead to IRS audits, penalties for accuracy-related issues, and interest on any unpaid taxes. A skilled tax professional can help you avoid these pitfalls when reporting crypto transactions and ensure compliance.
Contact Rolleri & Sheppard CPAs to Learn How We Can Help
If you’re a cryptocurrency investor or trader, it’s vital to have an experienced tax professional to assist you in navigating your tax obligations. At Rolleri & Sheppard, CPAs, LLP, we offer a wide range of tax and accounting services to cryptocurrency investors and traders to help them remain compliant while maximizing potential savings. Contact us online or call (203) 259-CPAS to schedule a consultation to learn how we can assist you.
