As we approach the close of a record year in crypto history, we also need to start thinking about taxes.
TL;DR: Crypto has its own unique tax treatment. Depending on whether you are earning crypto as income, purchasing NFTs, or trading cryptocurrencies, there may be different tax implications. Filing taxes for crypto transactions can quickly get unruly to manage given the complex tax treatment and the ever-shifting regulatory landscape. Keeping detailed records of your crypto transactions can help ensure your taxes are optimized.
How will my crypto be taxed?
When it comes to taxes, BTC/ETH is treated as property. This means that every time you spend, trade, or exchange cryptocurrency, that creates a taxable event. How much taxes you have to pay on a cryptocurrency transaction is determined by three factors:
- Market value of the coin at the time of the transaction (Proceeds)
- How much you paid for the coin (The cost basis)
- The difference between (1) & (2). (Gain or loss)
Capital gains tax (0%, 15% or 20%) or ordinary income tax (10% - 37%) applies on any gains, depending on how long you’ve held the asset (longer than a year or less than a year, respectively). Capital losses can be deducted against capital gains and, if you are in a net loss position, deducted against other income up to $3,000. Losses exceeding $3,000 will carry forward yearly until they are entirely depleted.
DISCLAIMER: As changing as the crypto industry itself is, the IRS hasn’t made sweeping changes. Every instance has to be examined by a tax professional. If you have questions about your crypto holdings and tax obligations, consult your Tax Advisor.
How will I be taxed on crypto earned as income?
If you receive cryptocurrency as wages, it is treated as ordinary income and subject to taxes. For instance, if you work at Coinbase and you get part of your paycheck in BTC, that’s subject to the same medicare, SSN, state/local taxes.
If you’re consulting for crypto, you may have to sell some crypto to pay taxes or use cash on hand, since you will be subject to self-employment income tax. For self-employment income, the amount of income is equal to the FMV of crypto when you received it (average of the high and low value on the day you received the payment). You can also pull the actual blockchain and get the actual USD value when it was transferred.
If you are mining crypto, that’s counted as ordinary income. If you are using specific computers or machinery to mine, you could write that off as a business expense. Gas use can also be expensed or capitalized. Business expenses and fee treatment should be determined on a case-by-case basis, depending on your level of involvement in the activity.
Specific ID Rule
The IRS prefers that you use the “Specific ID” method to figure out the cost basis of each unit of crypto asset you are disposing of. Specific ID means that each time you are disposing of your crypto asset, you are specifically identifying exact units you are selling. In order to use this method, you must keep detailed records of ALL the following information:
- the date and time each unit was acquired
- your basis and the fair market value of each unit at the time it was acquired
- the date and time each unit was sold, exchanged, or otherwise disposed of
- the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.
If you do not identify specific units of virtual currency, it defaults to the first in, first out (FIFO) rule; that is the units are deemed to have been sold, exchanged, or otherwise disposed of in chronological order starting with the earliest unit of the virtual currency you purchased or acquired. This is important because it may have detrimental tax implications.
For instance, if you bought 3 BTC in 2012 and 1BTC in 2021 (in the same wallet) that you have been using to purchase products with, you want to detail that you're using the newer, higher-basis BTC for liquidity or you'll have to pay tax on gains of your initial, low-cost basis, long-term investment.
Although crypto is subject to short- and long-term gains, there is a current debate on whether or not wash sales apply—which state that if an investment is sold at a loss and then a purchase of the same asset is made within 30 days of the transaction, the initial loss can be claimed for tax purposes. Consult with your tax advisor for guidance if you are uncertain.
How are NFTs taxed?
NFT transactions are subject to taxes. Your tax burden can be quite substantial, so it is important to plan ahead.
If you’re a creator, the taxable event is triggered when you sell your NFT(s). The proceeds are subject to ordinary income taxes and sometimes self-employment taxes (15.3%). Creators can deduct ordinary and necessary business expenses including hosting fees. If you’re a collector or investor, the taxable event is triggered when you purchase AND when you sell your NFT. If you’re purchasing with crypto, e.g., ETH or BTC, a taxable event occurs upon the disposition of that ETH (treated as property).
If you sell your NFT, any gains made would be subject to ordinary income tax if held for less than a year, or long-term capital gains (0% to 20%) tax if held for longer than a year. There is no formal guidance regarding the tax classification of NFTs, but there is a risk that NFTs could be treated as collectibles, which are subject to a higher tax rate (28%). This will implicate NFTs held for longer than a year.
If the NFT generates recurring revenue streams (e.g., royalties or re-sell proceeds), those proceeds are also subject to ordinary income tax. If the platform takes a fee, you can count those expenses against income. As NFT marketplaces do not provide 1099s, it is important to keep records of your NFT transactions and to plan ahead to ensure you have funds to pay your tax obligations.
How are DeFi assets taxed?
Currently there is no governmental guidance on “wrapped” cryptocurrency, to the extent that you trade ETH for a wrapped Ethereum (wETH), there’s a 1:1 conversion and you have the right to convert back at 1:1. This is likely not a taxable transaction, but there is currently no official guidance on this and that is subject to change. Please consult your tax advisor or a CPA for more information. In our next piece, we cover how you can donate crypto to charity for tax benefits.