Now that we know crypto is here to stay and we are just at the beginning stages of its adoption, one question I get asked all the time is “How is crypto taxed?” I thought this would be a great blog post to put out as I have seen a lot of incorrect information on this topic. So let’s dive into the truth behind crypto and taxes. Note: if you think you don’t have to pay taxes on crypto, you are in for a rude awakening.
How Is Crypto Taxed?
Cryptocurrencies are considered property for federal income tax purposes. This means crypto is considered a capital asset and you will pay the same tax when you ‘realize’ a gain or loss just like any other capital asset. By realize, I mean when you actually sell and realize the gain or loss, that is when the tax is determined.
The first thing you need to know to understand the tax liability you will have is the initial purchase price, this is your original cost basis. The tax you are going to have to pay is based on the difference between the selling price and your original cost basis. Example: You bought 1 Bitcoin at $10,000 and sold 1 Bitcoin at $30,000, so $30,000 -$10,000 = $20,000. This $20,000 is your gain, this is what you made off the sale.
The next step to determine how much tax you will pay is to figure out whether you will be taxed at short-term capital gains rates or long-term capital gains rates. This is a huge distinction that you need to know.
Short-term capital gains or losses are based on holding an investment for less than one year. If you sell within one year from the date you purchased said cryptocurrency, you will pay tax based on your income rate which is either 10%, 12%, 22%, 24%, 32%, 35%, or 37% (here’s a link to see which one you would be at based on your income). As you can see, if you are at a low-income rate, the short-term capital gains tax doesn’t seem so bad. But as income goes up, you could end up paying a lot of tax from the sale. Let’s say you make $600,000 and are in the 37% tax bracket, well using the example above, you would pay 37% tax on the $20,000 gain for a total of $7,400 in tax. This is something you have to be aware of so you don’t have a large unexpected tax bill come tax time.
Now long-term capital gains are taxed differently. If you hold an investment for longer than a year, you are either taxed at 0%, 15%, or 20% (note this could be increased based on the new tax bill that is being voted on). As you can see, long-term capital gains are given favorable tax treatments. Using the example above, if you are in the highest capital gains tax bracket, you would pay 20% tax on that $20,000 gain for a total of $4,000 in tax. This is a big difference! Oftentimes it can make sense to hold onto your investments for over one year to receive favorable long-term capital gains tax treatment. However, you don’t want to simply keep an investment just because of taxes, but it is something to factor in when thinking about selling if you are close to that one-year mark.
One thing many people don’t know is that you can offset capital gains with capital losses, but the offset first applies to gains and losses of the same type. This means that short-term capital losses offset short-term gains first. Then any remaining losses can be moved and used to offset the other type of gains. If you still have any losses after offsetting both short-term and long-term gains, then the loss can be used to offset up to $3,000 of ordinary income. If after that you still have some losses left, they will be rolled over to the following tax year.
Wash Sale Rules For Cryptocurrencies
As of now (this could get changed anytime), wash sale rules do not apply to cryptocurrencies as it does with stocks. This means you could sell your investment at a loss and then buy the same investment right back so you can have that loss to offset other gains. This is a powerful tool that can be used for tax-loss harvesting (offsetting gains with losses). With stocks, you would have to wait 30 days to buy the stock back after the sale due to the wash sale rule, but you don’t have to wait with crypto. This is a more complex strategy, so talk with your CPA or advisor on how to use it wisely.
As you can see, taxes are definitely something you have to be knowledgeable about when investing in crypto. You need to understand the difference between short-term and long-term capital gains and what tax rate/bracket you would be in for each so you can plan for the taxes you will owe.
As always, if you have any questions on crypto, crypto taxes, wash sale rules, etc. feel free to book a meeting and we can chat about it!
Disclaimer: Nothing on this blog should be considered advice, or recommendations. If you have questions pertaining your individual situation you should consult your financial advisor. For all of the disclaimers, please see my disclaimer page.