Most people know how to input W-2s, 1099s, and other tax forms they receive into their tax software to calculate what they owe (or get back) every year. But, while some crypto exchanges provide 1099s, the situation becomes much more complex if you use multiple wallets or exchanges or engage in activities beyond buying and selling cryptocurrencies.
Let's look at crypto taxes, 2023 tax rates, and a step-by-step guide to filing your taxes.
How Crypto Taxes Work
The IRS classifies all virtual currencies as "property," which means they're subject to capital gains taxes. In other words, for tax purposes, cryptocurrencies are never, in fact, "currencies," and non-fungible tokens (NFTs) are never "collectibles." As a result, you only have to worry about two types of taxes – capital gains and ordinary income.
- Capital Gains – A capital gain occurs when crypto assets you've held appreciate, and you realize a profit by selling them – including if you "sell" them to make a purchase!
- Ordinary Income – Ordinary income occurs when you receive crypto assets as compensation (e.g., mining) or interest (e.g., lending) or receive them via airdrops or rewards.
If you experience a capital loss – that is, your crypto assets depreciate and you sell them at a loss – you can generally use the loss to offset any capital gains or up to $3,000 in ordinary income. And, if you can't use the losses in the current tax year, you can typically carry them forward to future years to offset capital gains or income down the road.
2023 Tax Rates & Tables
The amount of tax you owe for capital gains or ordinary income depends on several factors, including your tax bracket and holding period. Generally, if you sold a crypto asset for a profit and had it for longer than one year, you will pay the long-term capital gains tax rate. Otherwise, you typically pay the higher ordinary income tax rate.
Long-term Capital Gains (> 1 Year)
When paying taxes, you pay progressively higher tax rates on each portion of your profit or income. For example, if you made $30,000 in short-term capital gains, the first $10,275 would be taxed at 10% ($1,028), and the next $19,725 would be taxed at 12% ($2,367), for a total of $3,395. In other words, you have an 11.2% blended tax rate.
Income vs. Capital Gains
Computing crypto income is relatively straightforward in most cases: You report the amount you received in U.S. dollar terms. So, for example, if you received 0.1 BTC from mining activities, you would note the U.S. dollar value of 0.1 BTC when you received it as income. And that's always taxed at the ordinary income tax rate.
However, there are some edge cases, such as:
- DeFi Reward Tokens – DeFi platforms that distribute interest or rewards by giving you additional tokens (e.g., AAVE) trigger ordinary income taxes on the value of tokens you receive.
- DeFi Share Tokens – DeFi platforms that distribute interest by increasing the value of interest-bearing tokens (e.g., Compound) trigger capital gains taxes on any increase in value.
- Governance Tokens – DeFi platforms that distribute governance tokens trigger ordinary income taxes on the value of the tokens.
There's also some uncertainty regarding whether some tokens are subject to taxation. For instance, the IRS has yet to declare whether wrapping tokens (e.g., wETH) are taxable transactions. So, if you have these situations occurring within your portfolio, you may want to consult a tax professional for advice. CPA’s like those at mactaxcpa.com who are recognized Zenledger Crypto Tax Professionals consider wrapped cryptocurrencies (even if they have the same value as non-wrapped cryptocurrency) a taxable transaction under current IRS rules and regulations (as of the time this article is published).
Computing Your Gain or Loss
Capital gains are a bit trickier to compute. Generally, your capital gain or loss equals your gross proceeds (the amount you received) minus your cost basis (the amount you paid). And typically, you qualify for only the lower long-term capital gains tax rate if you've held the cryptocurrency for more than one year before selling it.
The cost basis is the wild card. For example, if you made three purchases throughout the year and one sale, would you consider the first purchase the crypto you sold or the last purchase? The first purchase might push you over the one-year mark, enabling you to pay the lower long-term capital gains tax mark. But, it might also have a much lower cost basis.
The IRS uses the first-in, first-out (FIFO) method to compute your capital gain or loss by default. In other words, they match any sale with the earliest purchase. However, the agency also permits taxpayers to match specific transactions (specific ID). As a result, it's possible to use strategies like last-in, first-out (LIFO) or highest-in, first-out (HIFO). The best choice depends on your specific situation and market conditions. But, generally, the highest-in, first-out (HIFO) method produces the most tax savings. The downside is you need to match each transaction on Form 8949 (more on that below), which involves much more recordkeeping and adds complexity to your return.
3 Steps to File Your Taxes
#1. Aggregate Transactions
The first step in preparing your crypto taxes is aggregating your transactions across your wallets and exchanges. And then, you'll need to compute the U.S. dollar value of each transaction at the time it happened. This chronological record of transactions makes it much easier to determine your cost basis and calculate your capital gain.
ZenLedger automatically aggregates your transactions across different exchanges and wallets and computes your capital gain or loss. In addition, you can auto-populate Form 8949, Form 1040, Schedule D, and other forms you need to file your taxes.
The next step is completing Form 8949, where you will list each crypto sale. If you're using specific ID methods (e.g., a non-FIFO accounting method), you must identify which specific crypto units were involved in the transaction to substantiate your cost basis. Once complete, you sum up the total to determine your net capital gain or loss.
#3. Form 1040
The final step is carrying over the totals from Form 8949 to your Form 1040 Schedule D and adding any crypto income you received. You should always use these values rather than a 1099-B or other exchange-provided forms because exchanges don't necessarily have a complete picture of your crypto transactions and cost basis.
You might report crypto income in several areas.
- Form 1040 Schedule C – Business income from crypto mining or consulting income is usually reported on Schedule C unless you have a separate business entity or report it as hobby income on Schedule 1 (below).
- Form 1040 Schedule B – You’ll typically report interest income from staking or other activities on Schedule B.
- Form 1040 Schedule 1 – Free crypto from airdrops, forks, or any hobby income, is usually reported on Schedule 1. Note that you cannot deduct expenses if reporting hobby income.
The Bottom Line
Crypto taxes can quickly complicate your returns, particularly if you use multiple wallets or exchanges or participate in decentralized finance or other complex activities. Fortunately, ZenLedger can automate many tedious tax tasks, making it much easier to prepare your taxes. And, if you need extra help, you can quickly find a crypto accountant.