If you own cryptocurrencies or are willing to join the crypto revolution, there’s one aspect of it that you must know for sure — cryptocurrency taxes. Yes, there are tax implications on various crypto activities such as selling, exchanging, trading and others.
But it is essential to understand which tax is applicable to which crypto transactions. So how will we understand what type of tax we need to add for crypto trading, or a crypto exchange, and other such transactions?
In this article, we’ll answer your questions related to the taxability of crypto and understand the 3 types of crypto taxes that you’ll pay in 2021.
Tax On Cryptocurrency
The Internal Revenue Service (IRS) is mainly responsible for the regulation and authorization of cryptocurrency and its related activities. In 2014, the IRS issued a Notice 2014-21, which stated that cryptocurrency or digital currency will be treated as property and not fiat currency like, US dollar, Euro, and the likes. It reads:
In general, the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability.
Thus, for this reason, cryptocurrency is considered property for federal tax purposes. This might bring a lot of questions to your mind- Are all crypto activities taxable? What type of tax do we need to add for crypto? Let’s consider them one by one.
The 3 Types Of Crypto Taxes
In the United States, and also most countries like Canada and UK, there are 3 types of crypto taxes or taxable events, namely:
- Capital gains taxes
- Income taxes
- No-tax or tax-free
Now, let us discuss each of the 3 types of crypto taxes one by one and learn about all the different types of taxable events.
Capital Gains Tax
If you have held your crypto assets as investment, the profits that you incur from these investments are called capital gains, and this gain is subjected to taxes known as capital gains taxes.
Let’s simplify this concept and learn how to calculate capital gains taxes with the help of an example.
Suppose, you purchased $1500 worth of ETH in March 2021 and paid a $10 charge, so your cost basis is $1510. And in September 2021, you sold it for $2000. The formula for calculating capital gains is:
Capital gains = Selling price - Cost price - Fees
According to this formula, your capital gains will be $485 ($2000 - $1500 - $15). The amount of tax that you’ll have to pay as capital gains taxes will depend on the holding period of the cryptocurrency as well as the income slab that you fall under.
According to the holding period of crypto, capital gains tax can be categorized into the following:
- Short-term capital gains tax on assets held for less than a year
- Long-term capital gains tax on assets held longer than a year
Here's a rundown of the most typical crypto situations and whether they're subject to capital gains tax:
Selling Your Crypto Assets
As discussed in the example above, you’ll incur taxes when you sell off your crypto assets. Like, you sold the crypto assets that you owned for a certain sum of money and earned some profit from it. This profit will be subjected to capital gains taxes.
Exchanging Or Trading Your Crypto Assets
When you trade or exchange, like Bitcoin to Litecoin, and so on, these activities qualify for taxes. So what type of tax do we need to add for crypto trading?
Suppose you bought some Bitcoin and held them for some time and after a certain period of time you purchased Litecoin with it. So the IRS will consider this trade (BTC → LTC) as two transactions and tax them accordingly.
- Selling BTC for some profit (taxable)
- Buying LTC with the sum you earned (non-taxable)
Trading With Stablecoins
Stablecoins are also cryptocurrencies and are taxed the same as any other crypto-to-crypto transaction.
The plus side of stablecoins is that you won't have to pay any additional capital gains taxes if you swap the stablecoin for another cryptocurrency as long as its price stays constant. In terms of taxation, this puts them in the same category as fiats. It's worth noting that you'll still need to keep track of your stablecoin transactions for tax purposes.
Receive Crypto In ICOs
The cryptocurrency industry's equivalent of an initial public offering (IPO) is an initial coin offering (ICO) (IPO). An ICO is launched by a firm aiming to generate capital to build a new currency, app, or service.
The IRS states that a capital gain is only realized when you have complete control over the cash generated.
Is margin trading a taxable event too? The answer is yes! You can treat the funds that you’ve borrowed as your investment and pay capital gains taxes on margin transactions and loan repayment.
However, it must be noted that if you pay interest in cryptocurrency, then the interest you’d pay would qualify for capital gains tax. Why? Because it would be considered as a disposition of cryptocurrency, which is taxable.
Buying Goods & Services Using Crypto Assets
You can use cryptocurrencies to get pizza, a Tesla, or even a Netflix subscription, and you’ll be taxed the same way when you’re selling or trading cryptocurrencies.
Suppose you got a smart TV for 2 BTC. This transaction can be broken down into two steps.
- Selling your BTC for dollars
- Paying the seller with these dollars
Again, the disposition of cryptocurrency is taxable.
Now coming to the second type of taxes, among the 3 types of crypto taxes— income tax.
The income earned from crypto interests, staking, income from crypto mining, receiving crypto from airdrops, and hard forks are all considered income and are taxable as ordinary income.
Receiving Payment In Crypto
Even if you receive payment in the form of cryptocurrency from the organization you work for or freelance work, you’ll have to pay income taxes. But how is this taxed?
The tax on the coins that you received as payment depends on the market price at the time it was acquired.
Crypto tokens are used to compensate miners for their efforts, and the profits that a miner makes from these earnings are subjected to income taxes.
In this context, it must also be noted that selling off the mined coins for a profit will qualify as capital gains taxes and not income taxes.
Any cryptocurrency you receive in exchange for joining up for a service or recommending people to it is taxable as income.
Earning Interest From DeFi, Lending & Staking
Interest received through DeFi is taxed in the same manner that mining is. You must report it as additional regular income on your income tax return.
Because you still retain the assets and haven't disposed of them, the actual "loan" of coins is tax-free.
Airdrop & Hard Fork
The free delivery of crypto tokens or coins to several wallet addresses is known as airdrops. A hard fork is a significant modification to a blockchain network's protocol that renders earlier invalid blocks and transactions valid or vice versa. In 2019, the IRS officially declared that any airdrops or forks must be taxed as income taxes.
- According to the IRS, the coins that are received as a result of a hard fork are taxed at their fair market value. Whenever a new blockchain becomes online, its FMV becomes zero. Thus, you only have to pay capital taxes at the time you sell them.
- But if there is a delay (caused by any third party, an exchange, for example) in receiving the coins, you will only be taxed after the coins are in your possession. In this case, the FMV of the coins is expected to change, so you have to report them as income taxes.
Coming to the last among the 3 types of crypto taxes. Well, this one’s not exactly a tax, because this category deals with the crypto activities that are tax-free. Yes, you read it right- crypto transactions that do not incur taxes.
Buying crypto is tax-free. So if you purchased a complete stack and still have it, you do not have to face any tax obligations.
Whether you’re feeling generous or looking for a way to save some taxes, you can choose to give away cryptocurrency in the form of gifts to your friends or family. In the United States, the IRS allows you to send crypto up to $15,000, which can be executed in multiple transactions
In case the value of your gift exceeds the threshold of $15,000, you must report it in Form 709 and file for gift tax.
You can also claim a tax deduction when you make donations to registered charitable organizations in the US. The amount to be deducted, however, depends on the holding period of the crypto assets:
- You can deduct 30% of your Annual Gross Income if you’d held the assets for over a year.
- You can deduct 50% of your Annual Gross Income, and lower the cost-basis or FMV that have been donated if you’d held the assets for less than a year.
There are no tax implications when a cryptocurrency's underlying technology changes. For instance, when EOS moved from the Ethereum blockchain to the EOS mainnet or when DAI changed its contract address and renamed the previous coin SAI.
To put this in simpler terms, you will not have to pay tax on the exchange if the coin is switched at a 1:10 ratio or 1:1 ratio, as long as the value of your assets stays intact.
Transferring Cryptocurrency Between Own Wallets
Lastly, transfers between your own crypto wallets or crypto exchange accounts are tax-free. But you should keep track of all your transfers so you can show ownership of the sending and receiving wallets in the event of an audit.
To help make this process easier, you can take advantage of the best crypto portfolio trackers, such as Kubera, KryptoGraphe, ZenLedger, and various others. How can these trackers help you? ZenLedger, for example, allows you to keep track of your crypto assets, follow price movements, and identify tax savings all from one easy ZenLedger dashboard.
This will finally help you access your crypto profits and losses and also track your trades and other asset allocations for fuss-free tax filing.
The Bottom Line
And that’s everything you need to know about the 3 types of crypto taxes that you’ll pay in 2021. Even though all of this may seem a little overwhelming, keeping records and tracking your crypto activities will help you calculate, file, and report your taxes easily.
ZenLedger easily calculates your crypto taxes and also finds opportunities for you to save money and trade smarter. Get started for free now or learn more about our tax professional prepared plans!