Crypto Taxes: Paying Capital Gains On Bitcoin And Ethereum
Cryptocurrency is one of the hottest new investing trends of the past decade. Here's a detailed guide to understanding the tax ramifications of investments in this arena.
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Who Must Pay Taxes on Cryptocurrency?
Virtually anyone with meaningful profits in cryptocurrency has to pay tax on their gains. There are some exceptions for lower-income people who only have long-term cryptocurrency gains. However, almost all profitable cryptocurrency investors will have to share a cut of their gains with the IRS sooner or later.
And, in many cases, that day is sooner. There are numerous events, such as trading one cryptocurrency for another cryptocurrency, which cause immediate tax liability. It's not just the sale of Bitcoin or Ethereum for U.S. Dollars which causes a tax hit. Here are the full details on cryptocurrency taxation in 2023.
Do Bitcoin, Ethereum and Other Crypto Taxes Differ?
The IRS views what it deems virtual currencies, such as Bitcoin, Ethereum, and other coins, as forms of property. The IRS' document about virtual currencies bunches all of them in the same category, as transacted property. Thus, there is no distinction between various cryptos such as Bitcoin or Ethereum.
Crypto Taxable Events
- Selling a cryptocurrency for fiat money: The sale of Bitcoin, Ethereum or other cryptocurrencies for dollars, euros, or other fiat currencies is a taxable event, with tax due on the amount of gain between the purchase and sale prices.
- Trading one cryptocurrency for another: Exchanging Bitcoin for another cryptocurrency does constitute a taxable event. Taxpayers should calculate the amount of gain they made in the first currency at the time of transaction and then establish a new cost basis for the second cryptocurrency at the same time.
- Staking or lending cryptocurrency to receive interest or rewards: Money earned for lending or staking cryptocurrencies is treated as taxable income.
- Being paid for services in crypto: If a person or business sells products or services in exchange for cryptocurrency, the receipt of such funds is a taxable event.
- Using cryptocurrency to purchase items: If a person uses cryptocurrency that had appreciated in value to purchase an item, the difference between the cost basis and the value of the subsequent transaction would be taxable. For example, if a person bought $2,000 worth of Ethereum and then later bought a $3,000 NFT with that same Ethereum, the $1,000 gain would be taxed.
Important: Selling a cryptocurrency in exchange for a stablecoin such as Tether or USD Coin is a taxable event. Just because a transaction doesn't end up in U.S. Dollars doesn't make it exempt from taxation.
Crypto Capital Gains Tax Rate
Since cryptocurrency is taxed like other kinds of property, it follows the same capital gains tax treatment as for stocks and other financial assets. As such, any cryptocurrency held for less than 12 months counts as a short-term capital gain and is treated as ordinary income. However, unlike stocks, cryptos are not subject to the "wash rule," so investors can purchase the same digital assets immediately after selling them.
Since cryptocurrency is taxed like property, crypto transactions also become eligible for long-term capital gains tax treatment after a 12 month or greater holding period.
How Crypto Gains Are Taxed: An Example
Like with stocks, it is important to keep track of one's entry and exit prices for cryptocurrency transactions. This is especially true since swapping one cryptocurrency for another is a taxable event in its own right, and things can get confusing for traders who are frequently moving in and out of various coins and tokens.
For a detailed example, consider the following hypothetical investment. Someone buys $10,000 of Bitcoin. Six months later, it has appreciated to $15,000, and they sell the BTC at that price to buy Ethereum. This generates a $5,000 short-term capital gain.
One year later, Ethereum has rallied, and now this holding is worth $18,000. At that time, the investor gets excited about a new NFT project and puts all $18,000 into said NFT. This generates a $3,000 long-term capital gain. After three months, the NFT project has failed to capture the public's fancy, and the investor sells it for $13,000 of Ethereum, triggering a $5,000 taxable loss. Ethereum rallies over the next month, and the investor decides to step to the sidelines, swapping their now $15,000 of Ethereum for a stablecoin pegged to the U.S. Dollar. This last swap causes the recognition of a $2,000 short-term capital gain.
Crypto & Bitcoin Mining Taxes
If a person mines cryptocurrency, or otherwise receives newly-created cryptocurrency such as through a promotional event, this generates an immediate tax liability. The taxpayer owes taxes on all of the value of this newly-generated cryptocurrency at the market value of that asset on the day it was mined or created.
There can be two distinct tax liabilities on a mined coin:
- Say a miner earns a new Bitcoin when it is trading at $30,000. That would generate an immediate taxable liability on that $30,000.
- If the price subsequently rises to $50,000 and then the miner sells off that coin, they would owe an additional tax on the $20,000 capital gain between when the coin was mined and when it was sold.
Are Crypto Fees Tax-Deductible?
Generally, yes. However, there is an important note. Up until 2018, taxpayers could itemize investment-related expenses. This ability went away with the passage of the Tax Cuts and Jobs Act in 2017. Now this option for itemizing investment-related expenses, including crypto fees, no longer exists.
As an alternative, however, most taxpayers can simply adjust their cost basis to include commissions or transaction fees. For example, if a taxpayer purchased $5,000 of Ethereum and paid $100 of commission in doing so, he or she could report a tax basis of $5,100 on that purchase of Ethereum. The same goes for adjusting a sales price of cryptocurrency to account for transaction fees.
Tax-Efficient Crypto Investing Strategies
Since the IRS taxes crypto as property, investors can treat it like most other financial assets. That is to say that, in general, tax-efficient strategies for managing stocks also apply to cryptocurrency.
1. Putting Crypto in a Tax-Sheltered Account
To avoid immediate tax liability entirely, an investor can put cryptocurrency assets in a tax-sheltered account such as a self-directed IRA. There are still some obstacles to investing in crypto via IRAs, but this may change over time as additional exchange-traded funds become available which deal in cryptocurrency.
2. Matching Gains with Losses
Beyond that, general smart strategies apply to cryptocurrency as well. One can match gains with losses to offset them. For example, one could consider selling some cryptocurrency positions that are underwater if they would offset a big realized gain in the same tax year.
3. Keeping To a 12 Month+ Holding Period
Another simple but effective tool for lowering tax liability is to keep to a holding period of at least 12 months. That transforms short-term capital gains into long-term capital gains, which can reduce a tax liability dramatically.
Important: While crypto is volatile, making short-term trading appealing, there are considerable tax benefits for transactions lasting at least 12 months.
Bottom Line
In the beginning days of crypto, it might have seemed like a tax-free domain. However, the IRS and other regulatory authorities are rapidly catching up to the cryptocurrency market. Going forward, investors will need to report their transactions and use tax-efficient strategies to maximize their total returns in the cryptocurrency market.
This article was written by
Ian worked for Kerrisdale, a New York activist hedge fund, for three years, before moving to Latin America to pursue entrepreneurial opportunities there. His Ian's Insider Corner service provides live chat, model portfolios, full access and updates to his "IMF" portfolio, along with a weekly newsletter which expands on these topics.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (17)
Example illustrating calculation of a Shareholder's 2020 Grayscale Bitcoin Trust (BTC) Expenses
Assume that a Shareholder purchased 20,000 shares on February 15, 2020 and sold them on September15, 2020. For the month of February, Shareholder's expenses are $0.01463718 (See Summary Table
above – February Factor) x (14/29) = $0.00706622 per share. For the months of March through August,the expenses per share are as shown in the summary table above. For the month of September,Shareholder’s expenses are $0.01651842 (See Summary Table above – September Factor) x (15/30) =$0.00825921. The total expenses for Shareholder are therefore $0.10349882 per share (sum of allfactors from February 15th through September 15th) multiplied by the number of shares held (20,000),
or $2,069.98.
Total Expenses per Share $0.10349882
Number of Shares Held 20,000
Total Expense $ 2,069.9Their may be other complications. No thanks!!!