How Does the IRS Treat Cryptocurrency for Taxes?

Cryptocurrency has exploded onto the scene and adoption from retail investors is growing greater by the minute. With the end of the year quickly approaching, both seasoned and new cryptocurrency investors may have questions about the tax liabilities they may have generated. Let’s delve into this topic so you’re prepared ahead of time.

Property vs. Fiat Currency

Based on the name, many investors and users of cryptocurrencies may assume it is treated as a currency for tax purposes. However, the IRS does not treat cryptocurrency as currency for tax purposes. Instead it treats it like property. What does this imply?

This classification means that cryptocurrency transactions are treated differently than transactions involving traditional fiat currencies such as the U.S. dollar. Unlike fiat currencies, most cryptocurrency transactions are considered a taxable event. This means that a cost basis is assigned to your cryptocurrency upon acquisition and disposal. As you can see, depending on your cryptocurrency activity level, this can create a long list of transactions to reconcile as a part of your taxes each year.

Transaction Types

As we noted above, nearly all cryptocurrency transactions are taxable events. That said, there are caveats of which you should be aware. For example, if you were to use a credit card that offers cryptocurrency as a form of rewards, the rewards received in cryptocurrency are not taxable upon receipt just like their fiat currency counterpart.

However, not all cryptocurrency income is the same. Should you choose to lend your cryptocurrency and receive interest in return, the interest received will be taxable as income at the value of the cryptocurrency received at the time of payment.

Another example of taxable passive income earned through cryptocurrency is staking rewards. Staking is the process of delegating your tokens to a validator to secure a decentralized network in exchange for making the network more secure; the network emits rewards and pays them out on a pro-rata basis. These rewards are taxable income and measured at the value of the cryptocurrency at the time the reward was paid.

Capital Gains Taxes

We’ve covered how cryptocurrency is classified and its taxability, now let’s take a look at the rates that apply to the taxable transactions. There are two main rates to be aware of as a cryptocurrency investor: long-term capital gains and short-term capital gains.

Long-term capital gains are paid when the time between the date you purchased the cryptocurrency and the date you dispose of the same cryptocurrency is greater than one year. The long-term capital gains tax rates are more favorable than short-term capital gains rates. For example, the top bracket for 2022 long-term capital gains tax is 20%. Inversely, short-term capital gains are typically taxed at ordinary income tax rates, meaning they’re subject to a top bracket of 37%.