Have cryptocurrency tax rates got your head spinning? Don’t worry, we’ve got you covered.
The rise of cryptocurrencies and the high profits that can come with them have driven governments to rethink and, in many cases, tighten their taxation policies to regulate crypto-based profits.
Yet the value of cryptocurrencies is ever-changing and fast-moving, and therefore so is what an investor potentially earns when they buy and sell digital currencies. It’s much like securities growth investing, where securities are often bought and sold in quick turnarounds. In both cases, keeping track of all digital currency transactions takes some effort. To boot, there’s currently no global, standardized framework for current regulatory taxation frameworks.
It’s worth pausing for a minute to get your bearings. Like any other asset class, you will pay tax if you sell for a gain. Check out our comprehensive list of the hows and whys that will get you through this tax season (and the next!) with dollars in your pocket.
The basics of cryptocurrency tax rates
Cryptocurrency tax rates are all about short-term capital gains vs. long-term capital gains tax. Let’s break it down.
A capital gain occurs if an asset’s value increases between the time it’s purchased and the time it’s sold. If you buy a stock for $10 and sell it for $20, you’ve experienced a capital gain. On the flip side, if you sell it for less than you paid for it you’ve experienced a capital loss.
The IRS is, no surprise, interested in your capital gains. It uses its own calculation, called an adjusted basis, to find out whether or not there’s been one. Typically, the adjusted basis of an asset, any asset, is what you paid for it. If you paid less than its market value or received it as a gift, that capital gain (aka the adjusted basis) is derived from the item’s fair market value at the time you were given the item.
After an adjusted basis, the next differentiator is whether you will pay short-term or long-term capital gains tax on your cryptocurrency. The keyword here is duration. How long you hold the asset impacts the tax rate for your cryptocurrency.
Long-term vs. short-term capital gains
Your holding period dictates the tax rates on your cryptocurrency: whether you pay income tax rates or capital gains tax rates on your cryptocurrency holdings. You will pay short-term capital gains if you hold an asset for less than a year and long-term capital gain if you hold it for more than a year.
Here’s an example of how capital gains are calculated: Imagine you buy 60 shares of stock valued at $100 each. Six months later, you sell those 60 shares for $120 each, a total of $7200. Your capital gain is the purchase price, $6000, subtracted from the final sale price, $7200. You will realize a short-term capital gain of $1200.
Note that if the stocks had been held for six years, instead of six months, you would have paid long-term capital gains.
Cryptocurrency gains are taxed exactly the same as any other asset. It’s quick math. The purchase price subtracted from the purchase price to determine the adjusted basis, and then consideration of how long you held the asset.
See below for 2021’s federal income tax brackets.
Short term capital gains tax brackets (for crypto and other assets owned less than 1 year)
Long term capital gains tax brackets (for crypto and other assets held for more than 1 year).
And that’s all you need to know about cryptocurrency tax rates.
One caveat: Keep track of your transactions as you make them throughout the fiscal year. That way, you won’t be surprised by the tax rates on your cryptocurrency holdings, and you’ll be prepared when tax time inevitably rolls around. You may find yourself making a strategic sale to minimize short-term capital gains, or -- who knows? -- earn a tax refund. After all, success is 90% preparation, 10% perspiration.