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How will the IRS tax my cryptocurrency?

by | Jun 25, 2021 | Firm News |

Cryptocurrency has been around for over a decade now. While some people shy away from investing in this unpredictable new form of carrying out financial transactions, others have made it a point to include various cryptocurrencies in their diverse investment portfolios. Depending on when you purchased your cryptocurrencies – and how long you have been holding them – it’s possible that you’ve made a considerable profit from your initial investment. So, when it comes time to file your taxes, you might be wondering how U.S. tax law applies to cryptocurrencies.

IRS tax classification of cryptocurrency

The IRS taxes assets differently based upon their classification. In 2014, the IRS officially classified cryptocurrencies as capital assets, thereby establishing the procedure for calculating how much taxes are owed on them.

You don’t owe taxes merely for holding capital assets. Rather, you are taxed only when you sell them, and only if you sold them for more than you paid for them. The increase between your sale price and your purchase price is what triggers capital gains taxes.

When Bitcoin – the most well-known cryptocurrency – was brand-new, each Bitcoin was worth approximately 30 cents. Now, you can buy or sell a single Bitcoin for nearly $35,000. If you were to have purchased them early on and then sold them years later, you would have made a remarkable profit – but you would also owe a considerable amount of capital gains taxes, since your sale price was so much higher than your purchase price.

Reporting requirements for taxes

If your investment portfolio contains Bitcoin or any other cryptocurrency, there is no reporting requirement. Your capital gains tax liability only triggers if you sell your cryptocurrency at a profit. The rate of taxation that applies to your sale depends upon whether you held the cryptocurrency for more than a full year before you sold it.

In other words, if you own cryptocurrency or sold it at a loss, you don’t have any tax liability on it. If you sold it at a profit after owning it for less than a year, you will pay your regular income tax rate on it. If you sold it after owning it for more than a year, then you will have to pay a long-term capital gains tax on it.

The world of cryptocurrency is a new and exciting field, and the law surrounding it is ever-changing. It’s important to stay informed as to new IRS rulings concerning reporting requirements and tax rates, so that you can avoid an audit and the possible fines that accompany it.