Whether you’re a seasoned cryptocurrency investor or a novice brand new to investing in cryptocurrency, the question of how is cryptocurrency taxed can be daunting.
One common misnomer most cryptocurrency investors believe is because cryptocurrencies are not backed by any government, thus less oversight than traditional fiat currencies, that they’re investing in an asset that won’t be taxed in the future. In reality, this couldn’t be further from the truth. Whether you’re trading NFTs or you finally sold the Bitcoin you’ve been holding onto for months, there are tax implications that come with each transaction.
How Does the IRS Treat Cryptocurrency?
Now that we have established cryptocurrency transactions are subject to taxes, we must understand how the IRS classifies these assets.
In the eyes of the IRS, cryptocurrency is classified as property and therefore is subject to tax rates paid for capital assets. Other examples of capital assets include homes, cars, stocks, or bonds.
Like all capital assets, you must calculate your tax liability at the point of disposal. If the asset is held for longer than 1 year, it is subject to the more favorable long-term capital gains tax rate. However, should you buy an asset and sell it inside of a year it will be taxed at the short-term capital gains tax rate.
Not All Transactions Are the Same
While it may seem simple and straightforward, there is another layer of detail that further determines how each transaction is taxed. The two main layers of detail include how the asset was acquired and the type of capital asset that was acquired.
How the capital asset was acquired can drastically change the tax liability associated with it. For example, cryptocurrency acquired in a manner similar to credit card rewards isn’t taxable as income until it’s sold.
The next layer to consider is the type of capital asset that you’re holding. Should you elect to buy and sell NFTs, depending on the type of NFT, it may be deemed collectible from the IRS. Therefore, if the asset being traded is a collectible, it will be subject to the collectible tax rate, which is higher than long-term capital gains tax rates.
Using Cryptocurrency to Purchase Goods or Services
The last major bucket to consider when calculating your tax liability related to cryptocurrency transactions is using them to pay for goods and services. Should you elect to pay for a good or service using cryptocurrency, you will treat that as a disposal of the cryptocurrency and any gain or loss on the transaction will be calculated at the point of sale.
Although next tax season seems far away, it’ll be here before we know it. The sooner you engage a cryptocurrency CPA to assist in the calculation of your cryptocurrency tax liability, the sooner you’ll realize the benefits such as greater insight into your tax position prior to year-end, calculating the correct tax liability by transaction, and proper documentation for filing your taxes.
If you have additional questions about choosing a crypto CPA, don’t hesitate to reach out to our team at Founder’s CPA for guidance!