The crypto market is constantly growing and crypto investors and beginners are always on the lookout to make their name in the list of 'rags to riches.' Along with investments, the masses have also found alternative ways to make money from crypto activities like trading, mining, swapping, and so on.
Owing to this increased interest, it is crucial to understand that the Internal Revenue Service (IRS) considers cryptocurrency as property or asset and not currency. Thus, one must understand the importance of filing cryptocurrency taxes with the correct tax rate for each transaction that takes place on the blockchain.
Let's take a look at the Bitcoin tax rate in the U.S. and the various types of taxable events.
Bitcoin Tax Rate
The IRS considers cryptocurrency as "property" which means that all crypto holders need to pay a capital gains tax rate on their crypto taxes. In other words, if you're holding or making a profit from crypto investments, you must pay the capital gains tax rate on the held currency. This capital gains tax rate is similar to the tax rate for federal taxes.
- The U.S. Bitcoin tax rate is calculated based on your income and the holding period of your crypto assets.
- The holding period of your Bitcoin starts the day after the crypto purchase has been made and proceeds till the day it is traded, sold, or sent.
- It is this holding period that defines whether you have incurred a short-term capital gain or a long-term capital gain.
- At present, the Bitcoin tax rate for short-term capital gains varies from 10-37% and long-term capital gains vary from 0-20%.
Short Term Capital Gains Tax On Crypto
When the holding period of your cryptocurrency coins is a year or less, specifically 365 days or less, it will be taxed as ordinary income and you owe taxes when gains are realized. This gain will be subject to short-term capital gains tax.
Long Term Capital Gains Tax On Crypto
When the holding period of your cryptocurrency coins is more than 366 days, it will be taxable as ordinary income. Based on your ordinary income tax rate, your capital gains taxes will vary from 0-20%.
Cryptocurrency Taxable Events
You now understand that you’ll need to pay taxes on your crypto at the time of a taxable event - but what is a taxable event? Any event where you incur profits is a taxable event.
The tax rate on Bitcoin profits is categorized into two types of taxable events:
- Capital gains tax events
- Income tax events
Both of these events are taxed in two different ways and it is important to understand which category your crypto investments fall under.
Capital Tax Events
Capital tax events incur both short and long-term capital gains. The following is a list of capital tax events:
1. Selling Crypto For Fiat Currency
When you sell your cryptocurrencies for fiat currency like Euro, Pound, or U.S. Dollar, it is considered a capital tax event. For instance, you have purchased 1 ETH for $500 and after a few months, you sell them at $400. It is clear that you have incurred a capital loss and this loss of $100 will be subtracted and decrease your total taxable income.
2. Buying Goods & Services Using Crypto
When you use crypto to buy goods or services, this too is considered a capital tax event. For instance, in a Bitcoin transaction in 2013, you'd bought 6 BTC, each at $150. As the value of Bitcoin has increased over time, you can use 1 BTC to buy goods and services worth $45,000. This is a capital tax event as you incur a capital gain of $44,850($45,000-$150) and this needs to be reported in your taxes.
2. Swapping Or Trading One Crypto For Another
Investors can swap or trade one type of cryptocurrency for other types on crypto exchanges and peer-to-peer exchanges. Suppose you bought 20 Litecoin for $1,000 and traded them for 2 ETH (Ethereum). At the time of the trade, the value of 20 Litecoin was $3,000. So you realized a capital gain of $2,000 ($3,000-$1000) when you swapped Litecoin for Ethereum. This needs to be reported on your taxes.
Having said that, it must be noted that transferring funds from one exchange to another, or from one wallet to another is not a taxable event, because no crypto gains or losses are triggered.
Income Tax Events
The following is a list of income tax events:
- Receiving interest from decentralized finance lending
- Receiving cryptocurrency via airdrop
- Receiving payment as you solve tasks and bug bounties
- Staking and liquidity pool profits
- Transaction fees and block rewards for crypto mining
The Bottom Line
Various transactions take place on the blockchain, and it is important to understand the tax purposes of these transactions and file them based on your capital gains tax rates and taxable income rates.