Cryptocurrencies have exploded in popularity over the past couple of years. That said, most cryptocurrency users are unaware of the technical nature in which cryptocurrencies are classified and subsequently taxed. Even more complicated is cryptocurrency accounting which needs to be factored in before taxes each year.
If you’ve always wanted to learn more about cryptocurrency but didn’t know where to start, use the below as a jumping-off point. Our experts are always here to help!
What Is Cryptocurrency?
Cryptocurrencies are tokens that operate as a digital medium of exchange. They allow users to process transactions that are verified and maintained by a decentralized system, a blockchain. Unlike fiat currencies, the IRS treats cryptocurrencies as property, and therefore they’re subject to different tax laws than currency.
Use Cases for Cryptocurrency
Before we get into how to account for cryptocurrencies, it is important to understand the different types of projects that exist in the cryptocurrency ecosystem. Cryptocurrencies are unique in that the type of transaction that is processed may drastically change the taxability of the transactions. For example, cryptocurrencies can be staked to secure the network. The user is then paid a reward, receiving income, for staking their tokens on the network. Cryptocurrencies can also be lent out to other users, who then pay the lender back with interest.
Though the two transactions above seem similar in nature, the tokens are loaned or staked and in return the user receives income. However, the IRS treats these transactions differently.
Tax Rates Change Based on How You Interact with Cryptocurrency
As we noted above, on paper cryptocurrency accounting may seem straightforward. That said, there are a lot of complexities beneath the surface.
It is critically important for cryptocurrency users to understand the intricacies of how income is earned with their crypto. For example, interest income earned for loaning your cryptocurrency out to other users is taxable income when received because the user is not creating any new property through securing the network.
This is just one example of the complicated nature of cryptocurrency accounting. Depending on the types of transactions you’re processing, your cryptocurrency may end up subject to a myriad of tax rates such as long-term capital gains, short-term capital gains, ordinary income, and collectibles.
Options for Calculating your Cryptocurrency Taxes
Accounting for your cryptocurrency taxes can be a cumbersome process. While it is always an option to manually compile, calculate, and file your cryptocurrency taxes it is often more efficient to use cryptocurrency taxes software or engage a crypto CPA. Software, or a crypto CPA, strongly reduces the potential for human error when dealing with complex cryptocurrency accounting.
If you have additional questions about choosing the crypto CPA, don’t hesitate to reach out to our team at Founder’s CPA for guidance!