Ah, tax season. For many Americans, it’s like the opposite of the holiday season – a time of stress, confusion, and potentially spending lots of money.
Actually, that sounds a lot like Christmas.
Anyways, whenever you dive into your tax software of choice, you’ll be hit with this question, front, and center:
“At any time during the year, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
Why the sudden and profound interest in my crypto, IRS? In this piece, I’m going to answer this question and more.
Let’s investigate cryptocurrency and your taxes.
Here’s why record-keeping is so critical
Cryptocurrency earnings are a little trickier to calculate and report than regular income.
When you receive regular income, the IRS will ask you how much you earned, and that’s about it. Plus, your regular income is neatly recorded on end-of-year forms like W-2s and 1099s. Even if you do receive “other income” not tied to a 1099, it’s often easy to calculate using your bank statements or Paypal transaction history.
In order to calculate your precise gains and losses from crypto, however, you need to know two numbers: the fair market value when you bought it, and the fair market value when you sold.
Now, if you’re lucky, your crypto broker will automatically calculate this for you and allow you to download a 1099-B or 1099-K summarizing your earnings, which allows for easier reporting on the other forms listed below. If not, however, you may have to calculate your crypto gains and losses by hand, researching old Bitcoin values on your buy and sell dates.
If the tedious process of digging up old trade data just so you can do math and pay taxes tastes sour in your mouth, well, take it as a sign to keep better records next year, or swap your wallet over to an exchange that will produce 1099s for you.
I know you wouldn’t, but seriously: don’t mess with the IRS
Whatever you do, don’t write off the IRS (pun intended) as a bunch of bean counters who won’t notice if a small-time trader doesn’t report their gains.
Remember, the IRS are badasses; they’re the ones who nailed Al Capone when no other federal agency could. And this year they’re specifically targeting crypto tax dodgers.
The IRS also seems well past giving warnings. They’ve already done so multiple times since 2014, culminating in 2019 when they issued 10,000 letters to crypto holders demanding their taxes and penalties be paid up ASAP, lest they face criminal charges.
Plus, your crypto transaction history is easier to track than you think. Every crypto transaction has a traceable record, and the IRS has already developed AI algorithms to trace and index every American’s crypto history. At the risk of sounding melodramatic, their ultimate goal is to leave nowhere for unreported crypto gains to hide.
What crypto activity do I have to report on my taxes?
To start, here’s a list of crypto-related activity that you don’t need to report:
- Buying crypto with cash and holding it (affectionately known as HODLing).
- Donating crypto to a qualified tax-exempt charity or non-profit.
- Transferring crypto between wallets.
The following, however, are taxable events that you do need to report, and may be taxable:
- Selling crypto for cash (even if you lost money on your initial investment).
- Using crypto to pay for goods or services (Tesla, etc.).
- Exchanging one crypto for another (i.e. swapping BTC for ETH).
- Mined crypto.
- Being paid in crypto or by airdrop.
- Receiving crypto as a bonus or a reward.
How do I report my cryptocurrency activity on my taxes?
The first thing you should know is how to answer this question on your Form 1040:
According to the IRS, if your only crypto activity was buying some with cash, you should answer “No” to this question. Again, if all you’re doing is buying and holding, you don’t have to report anything to the IRS (yet).
If you have done more with your crypto, your next step is to download Form 1099 from your crypto exchange platform. According to the IRS, in addition to uploading this form with your taxes, you’ll have to report your crypto activity in two places:
- On Form 8949, Sales and Other Dispositions of Capital Assets.
- On Form 1040, Schedule D, Capital Gains and Losses.
How much are the taxes on my crypto?
The taxes you’ll pay on your crypto will depend on how long you held it before selling.
If you held your crypto for under a year
If the crypto you sold in 2020 was purchased within a year of its sale date, your earnings will be taxed at your regular income tax rate.
If you held your crypto longer than a year
If the crypto you sold in 2020 was purchased more than a year before its sale date, your earnings will be subject to a long-term capital gains tax:
- 0% if you earn up to $40,000 per year.
- 15% if you earn up to $441,450 per year.
- 20% if you earn more than $441,450 per year.
What if I lost money or my crypto was stolen?
The IRS handles capital losses and theft completely differently.
If you lost money on cryptocurrency
If you bought high and sold low, there’s some good news: you can actually write off some of your cryptocurrency losses on your taxes.
On Form 8949, you can report up to $3,000 in net capital losses each year, which are then written off from your taxes.
Keep in mind, however, that this strictly pertains to losses as the result of a sale. If your crypto went missing or got stolen, things are a little different.
If your crypto is missing or stolen
It used to be that you could report lost or stolen property on IRS Form 4684 for a deduction, and since the IRS classifies crypto as property, it could be reported here.
However, the Tax Cuts and Jobs Act in 2017 eliminated this deduction. Now, the only “casualties and thefts” you can report for a deduction are those directly resulting from a federally-declared disaster.
You can see a list of federally-declared disasters on IRS.gov, but suffice to say, the IRS doesn’t care about your lost or stolen crypto anymore. I myself lost a bunch of dogecoin when a crypto exchange I used in 2017 cut and ran with our wallets, so it’s a bummer that I can’t get it deducted.
Are there any deductions?
There are two deductions you can make on your taxes related to cryptocurrency:
See above for details, but yes, you can report losses from crypto sales just like you report losses from the sale of stock. You can deduct up to $3,000 in capital losses from all sources on Form 8949.
If you donated cryptocurrency to a federally-recognized charity or non-profit, you can deduct the cash value of your donation on Schedule A (Form 1040).
So how should you calculate that cash value? According to the IRS, your charitable contribution deduction is one of the following:
- If you held the crypto for longer than a year, your charitable contribution deduction is equal to the fair market value of the crypto at the time of the donation.
- If you held the crypto for less than a year, your deduction is the lesser of a) your basis in the crypto or b) the crypto’s fair market value at the time of the donation.
Your “basis,” again, is the fair market value of the crypto when you purchased or received it.
Why is the IRS asking about my cryptocurrency?
The IRS is asking taxpayers about their cryptocurrency activity for two reasons: to tax your gains and to track your transactions.
In a statement released in 2014, the agency announced that they would begin classifying cryptocurrency as property, not currency, and that all taxpayers would have to report their cryptocurrency on their taxes moving forward.
Here’s the significance of classifying cryptocurrency as property, not currency. To set expectations early, it’s not great news for crypto traders.
The difference is best illustrated by analyzing two types of transactions: currency for property and property for property.
- Currency for property – When you pay cash to buy a Tesla, you’re exchanging currency for property. The car will be taxed, but the cash you use to buy the car will not be taxed at the time of transaction. In short, you won’t be double taxed.
- Property for property – When you pay Bitcoin to buy a Tesla (which is totally a thing, now), the IRS does not view this as the same as simply paying cash. Rather, they see it as you effectively selling your Bitcoin for cash, then using the cash to buy the car (even if those literal steps don’t happen). Therefore, you’re taxed on the sale of your existing property and the purchase of your new property.
Is the IRS doing this just so they can rain on the crypto parade? Not at all. That’s because cryptocurrency isn’t like the cash sitting in your bank account: predictable, stagnant, and suffering under inflation. Rather, it’s an investment like stocks or real estate: appreciating in value and generating income. And income in all forms is taxable.
Why is the IRS cracking down harder this year?
When you do your taxes this year, you’ll notice that the IRS has promoted their question about cryptocurrency to the top of Form 1040, even though fewer than 10% of Americans have crypto wallets.
The IRS is asking about your cryptocurrency about as “calmly” as Dumbledore for a few reasons.
Americans still aren’t reporting it
Despite millions of Americans buying, selling, and trading cryptocurrency each year, very few actually report it on their taxes.
How few? Very few.
According to the IRS, between 2015 and 2016, “only 800 to 900 taxpayers reported gains related to Bitcoin.” The agency quickly discovered that many traders “have openly acknowledged they consider using bitcoin in order to avoid tax reporting requirements.”
Digging further, the IRS discovered that on popular trading platform Coinbase, over 14,000 traders swap over $20k in Bitcoin annually. Yet virtually none of them reported so on their taxes. For that reason, the agency successfully subpoenaed Coinbase in 2019, seizing records and going after the tax dodgers.
The IRS/Coinbase episode didn’t just remind traders not to mess with the IRS; it highlighted just how easy it is for the IRS to track cryptocurrency transactions. There’s a record of every single crypto transaction online, after all, and the IRS has proven their ability to find it.
The value of Bitcoin has multiplied 10x since March 2020
The IRS’s crackdown on reporting crypto couldn’t have come at a better time.
That’s because Bitcoin, the world’s most popular cryptocurrency, has multiplied in value by a staggering 10x in under a year.
Bitcoin’s skyrocketing value is a big red flag for the IRS because it represents countless millions in unrealized capital gains. Crypto traders need to know, now more than ever, that they need to pay taxes when they sell or swap crypto.
Granted, not everyone will have realized gains through crypto this year, but imagine if those who do choose not to pay their taxes? The IRS will spend infinite resources filing subpoenas, auditing investors, and the U.S. government will still lose out on millions.
Crypto is becoming a fresh destination for old school fraud
Lastly, the IRS’ crackdown on crypto trading isn’t just about collecting unpaid taxes; it’s about protecting American investors.
The proliferation of “altcoins,” or alternatives to Bitcoin, has created a breeding ground for old-school investment fraud, especially pump-and-dump schemes. Anyone with a large audience of investors can simply buy a massive stake in a low-value altcoin, Tweet about it to their investors, then dump it all when it reaches a higher price.
In short, the IRS’ willingness and ability to look into fraudulent crypto transactions serves as another layer of protection for the average American trader.
If you trade crypto, it may feel like a bummer that the IRS is finally cracking down and taxing your new source of income. It’s hard not to picture them bursting into coin exchanges like old-fashioned cops in Bobby helmets, blowing whistles, and breaking up a decade-long party.
It might help just a little bit to frame it like this: the IRS is legitimizing crypto trading as a bonafide investment, finally taxing it alongside stalwarts like stocks and real estate. Plus, by keeping an eye on the bad guys they’ll be able to better protect you from fraud, and lastly, the millions they collect from high-volume traders will help pave roads and pay for public school.
Reporting your crypto activity on your taxes may come with a bit of a learning curve, but you’ll master the art quickly and get it done much faster next year and the year after.
In the meantime, keep HODLing the line.