Cryptocurrency Tax Implications: What Every Investor Should Know 

Cryptocurrency is still relatively new in our modern financial world, and many people are still unsure about how crypto taxes are treated. 

So, before tax season comes around, let’s talk about cryptocurrency tax implications and all of the things you should know before filing next year.  

Key Takeaways: 

• Cryptocurrencies Are Treated as Property: The IRS classifies cryptocurrencies as property, making them subject to capital gains taxes.
• Reporting All Transactions is Mandatory: The IRS requires every cryptocurrency transaction to be reported, even small purchases or crypto-to-crypto trades.
• Common Reporting Mistakes: Failing to report small transactions or crypto trades is a common error that can trigger IRS audits.
• Tax Software Simplifies Compliance: Using specialized crypto tax software helps track transactions and generate accurate tax forms.
• Maintaining Detailed Records is Crucial: Accurate transaction logs, receipts, and exchange statements ensure smooth tax reporting.
• IRS on Crypto Transactions: Large transactions, unreported income, and offshore holdings may lead to heightened scrutiny from the IRS.

Understanding Cryptocurrency Tax Treatment

Cryptocurrencies have grown — and are continuing to grow — in popularity, and with that comes the need for abundant clarity on their tax implications. 

Since the IRS treats cryptocurrencies differently from traditional assets, this impacts how gains and losses are taxed. Investors need to understand that any transaction involving cryptocurrency — whether buying, selling, or trading — can trigger tax consequences. 

After all, properly managing these transactions ensures compliance and can help reduce tax liabilities.

Are Cryptocurrencies Considered Currency or Property? 

The IRS classifies cryptocurrencies as property, not currency. This means that each transaction, whether it’s a sale or an exchange, is subject to capital gains tax. 

The classification as property also allows for the offsetting of losses, providing opportunities for tax planning. 

Understanding this distinction is crucial because it affects how investors calculate their taxable income from crypto activities, making accurate record-keeping essential.

How Gains are Calculated for Cryptocurrency 

When it comes to cryptocurrency investments, understanding how gains are calculated is crucial for tax reporting and liability management. 

Just like other assets classified as property, cryptocurrencies are subject to capital gains taxes when sold or exchanged. The amount of tax owed depends not only on the gain itself but also on how long the asset was held before the transaction.

Differentiating between short-term and long-term capital gains is a key factor in determining the tax rate you’ll face.

Short-Term vs. Long-Term Capital Gains

Essentially, cryptocurrency transactions are taxed based on how long the asset is held before being sold or exchanged. 

So, if you hold a cryptocurrency for less than a year, any profit you make from its sale is considered a short-term capital gain. These gains are taxed at the same rate as your ordinary income, which could be as high as 37% depending on your tax bracket.

On the other hand, if you hold the asset for more than a year, it qualifies for long-term capital gains tax rates, which are generally lower, ranging from 0% to 20%. 

This makes long-term holdings more tax-efficient for investors aiming to minimize their tax burden.

Reporting Requirements for Cryptocurrency Taxes 

The IRS requires all cryptocurrency transactions, whether you profit or lose, to be reported on your tax return. Two critical forms — IRS Form 8949 and Schedule D — are used to document cryptocurrency gains and losses. 

Here’s a simple guide on how to report your crypto transactions step-by-step:

1. Gather Transaction Records: Start by collecting detailed records of your cryptocurrency transactions, including dates, amounts, the value in USD at the time of the transaction, and any associated fees.
2. Complete Form 8949:
   • Part 1: For each transaction, list the date acquired, date sold or exchanged, proceeds (value in USD), cost basis, and your gain or loss.
   • Adjustment Codes: Use codes if your transaction qualifies for special treatment, such as correcting cost basis or adjusting for wash sales.
3. Transfer Totals to Schedule D:
   • Short-Term Gains and Losses: Add up the totals from your short-term transactions (held for less than a year) from Form 8949 and transfer them to Part I of Schedule D.
   • Long-Term Gains and Losses: Total your long-term transactions (held for over a year) and move them to Part II of Schedule D.
4. File with Your Tax Return: Include Form 8949 and Schedule D with your tax return to ensure all crypto transactions are reported correctly. 

For more detailed steps, you can read our blog: How to Report Crypto on Taxes: Complete Guide. 

Common Mistakes in Crypto Tax Reporting

It’s not uncommon for new crypto investors to unknowingly make errors when reporting their transactions, leading to potential audits or penalties. 

Below are some common mistakes to make sure you avoid when the time comes:

• Failing to Report Small Transactions: Even if the transaction seems insignificant, such as using cryptocurrency to buy a cup of coffee, the IRS still considers it a taxable event. Every transaction, regardless of size, must be reported.
• Not Reporting Crypto-to-Crypto Trades: Swapping one cryptocurrency for another (e.g., trading Bitcoin for Ethereum) is also a taxable event. Many investors overlook these trades, but they are subject to capital gains tax just like any sale or exchange of crypto for fiat currency.
• Ignoring Crypto Rewards: Income earned through staking, mining, or airdrops must be reported as ordinary income and is taxable at the time of receipt.

Avoiding these simple mistakes will help ensure your crypto tax filings are accurate and compliant. And this also means a whole lot less hassle in the long run. 

Cryptocurrency Tax Compliance Tips 

With the increasing complexity of crypto transactions and IRS enforcement efforts, it’s important to follow best practices for tax filing. Below are key tips that can help investors manage their crypto tax obligations smoothly and efficiently: 

1. Use Crypto Tax Software: 
   1. Automates tracking of all crypto transactions, including purchases, sales, and trades.
   2. Simplifies the calculation of short-term and long-term gains.
   3. Reduces errors by syncing with crypto exchanges to pull in transaction data automatically.
   4. Generates the necessary tax forms (e.g., Form 8949) for filing with the IRS.
2. Maintain Accurate Records:
   1. Keep detailed logs of every transaction, including date, amount, and value in USD at the time of the trade.
   2. Store receipts for crypto purchases, as well as any relevant documentation, such as transaction confirmation emails.
   3. Retain exchange statements to verify trades and transfers between wallets or platforms.
   4. Having a clear transaction history will make tax reporting easier and more accurate.
3. Be Aware of IRS Enforcement:
   1. The IRS is increasing its scrutiny of cryptocurrency transactions, especially as more investors enter the space.

Planning Ahead: Reducing Cryptocurrency Tax Liability

Understanding the tax implications of cryptocurrency is crucial for every investor. From calculating gains to filing the right forms and avoiding common reporting mistakes, proper tax compliance helps you stay on the right side of the law while minimizing potential liabilities.

For personalized guidance on navigating cryptocurrency taxes and optimizing your crypto tax strategies, you can contact our experts today. The Dimov team specializes in providing comprehensive tax solutions for technology and finance professionals, ensuring you’re fully prepared for tax season — and beyond.