November 26, 2021

How Does the IRS Handle Taxation of Cryptocurrency?

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Glen Frost

Crypto Traders Beware

Cryptocurrencies are relatively new in our universe, but they are widely believed to be the currency of the future. Like the currencies we use today, cryptocurrencies are used to purchase goods and services. However, they are still very much unregulated and many investors simply trade them for profit, which have sent their values soaring skyward. However, there is the question of how cryptocurrency affects your taxes.

Even as lawmakers are thinking about how to regulate this new world of currency, the Internal Revenue Service has been pretty clear in its stance: If you deal in cryptocurrency, you need to pay taxes on them. The tax laws involving cryptocurrencies are still a work in progress. So, how do you figure out whether you owe taxes or how much you owe on cryptocurrencies? Cryptocurrency tax planning can be difficult, so we wrote this guide to help you through.

When Do You Owe Taxes on Cryptocurrency?

If you buy Bitcoin or other cryptocurrency, you don’t necessarily need to report it on your tax return. It really depends on what you did with it after you bought it. Currently, the IRS treats cryptocurrencies as it would treat stock. So, if you purchased bitcoin and kept it all, you don’t need to report it on your tax return. However, once you sell the cryptocurrency and have a gain or loss, you must report it and pay taxes on capital gains, which are defined as a the difference between how much a certain property cost when you purchased it and for how much you sold it.

If the price went up, you made a profit. If it went down, then you suffered a loss. You would report cryptocurrencies on Schedule D, the same federal tax form you would use to report capital gains such as the profit you made from selling a piece of real estate. It’s also important to remember that if you paid employees using cryptocurrency, you need to report that to the IRS on a W-2. If you paid contractors with cryptocurrency, you’ll need to issue them a 1099. If you are a “cryptocurrency miner,” you need to report proceeds from mining bitcoin or any other cryptocurrency as part of your gross income.

These are calculated using the fair market value of the currency on the day it was mined.

Understanding the Complexities

The new tax laws also affect how cryptocurrency is treated by the IRS. Previously, for example, when you trade one type of asset such as real estate for another similar asset, such exchanges were considered tax-exempt. So, earlier, since cryptocurrency is viewed as an asset rather than currency, a trade was considered a non-taxable transaction. Since the new tax law has gotten rid of this type of exemption, you will need to pay taxes on such transactions.  Avoiding taxes on cryptocurrency transactions can be dangerous.

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