Owners of digital assets, including Bitcoin and other cryptocurrencies, face increased scrutiny from the IRS and other tax authorities. Whether you’re a seasoned trader of crypto assets or just dipping your toes into the world of virtual currency and non-fungible tokens (NFTs), it’s crucial to understand how buying, selling, exchanging, and receiving digital assets as compensation impacts your taxes. So, let’s unravel this together.

Do you have to pay taxes on digital assets?

First things first, when you buy, sell, or exchange digital currencies, it’s not just about watching your portfolio’s ups and downs. The IRS views cryptocurrencies as capital assets, which means these transactions can trigger capital gains or losses, just like selling stocks or real estate. Here’s the kicker: every single transaction could be a taxable event. Yes, even swapping Bitcoin for Ether counts.

Buying digital assets isn’t a taxable event, but spending virtual currency, selling crypto assets, or exchanging one digital asset for another that’s worth more than you paid for it creates a taxable gain under the U.S. tax code.

Selling digital assets

For example, say you’ve had a good year and decide to sell some of your digital assets. Any profit you make is considered a long-term capital gain if you’ve held onto it for more than a year. Long-term capital gains are taxed at a lower rate (0% to 20%) than short-term gains (those held for less than a year), which are taxed at the same rate you pay on ordinary income: 10% to 37%, depending on your federal income tax bracket.

But what if the market swings weren’t in your favor? In this case, the IRS allows you to use capital losses to offset gains. If your losses exceed your gains, you can deduct up to $3,000 ($1,500 if married filing separately) against other types of income. And if your losses are even bigger, you can carry them forward to future years.

Receiving digital assets as compensation

Receiving digital currency as compensation or bonus revenue adds another layer to the cake. If you’re paid in crypto for services rendered, the income is taxed based on its fair market value at the time you received it.

That compensation is subject to federal income tax and should be reported on your P&L — just as any other business revenue would be. If you are an employee and recieve digital assests as compensation, it should be reported as income on your W-2.

Mining or staking rewards are also taxable income at the time they’re earned. If you mine virtual currency as a trade or business, the net earnings from this activity are subject to income and self-employment taxes. Disposing of virtual currency held for sale to customers needs to be accounted for the same way businesses would account for the disposal of other inventory.

How to report capital gains & losses from digital assets

For most digital currency enthusiasts, the most common cryptocurrency transactions they’ll have to deal with are sales. If you exchange digital assets for goods or services, sell virtual currency, or exchange one type of digital asset for another, you likely have a capital gain or loss to report on your federal taxes.

Often, the biggest challenge in reporting these transactions for federal income tax purposes is determining the transaction’s cost basis.

According to the IRS’s Virtual Currency FAQs:

• The basis of virtual currency purchased with traditional fiat currency is the amount spent to acquire digital assets, including fees, commissions, and other acquisition costs.
• The basis of virtual currency received for services provided, such as for compensation or in a trade or business, is its fair market value, in U.S. dollars, when the virtual currency was received.
• The basis of property received in exchange for digital currency is its fair market value of the property at the time of the exchange.

Recent legislation requires cryptocurrency exchanges and platforms to report these transactions to the IRS and the investor on a 1099-B or a new form being developed by the IRS: Form 1099-DA.

However, because this requirement is relatively new, the exchanges and platforms might not have all the information they need to meet their reporting requirements. For example, if you purchased a digital asset on one platform and then transferred it to another exchange years ago, the new exchange might not have accurate basis information.

This could make the first few years of reporting digital asset transactions challenging.

Crypto taxes best practices

So, how do you keep your head above water in the sea of digital currency taxation? Here are a few practical tips:

• Understand the events that trigger taxable events, such as selling, trading, or spending your crypto.
• Keep detailed records of all your transactions, including dates, values, and what was exchanged. Tools and apps for tracking crypto transactions, like CoinTracker can be lifesavers here.
• Plan your trades with taxes in mind. Sometimes, holding onto assets a bit longer might make sense if you can benefit from lower long-term capital gains rates.
• Consult with a tax professional who understands digital currency. This field is evolving rapidly, and having an expert by your side can help you navigate it more effectively.

Embracing digital currencies comes with its set of challenges, but with the right knowledge and preparation, you can navigate the tax implications like a pro.

If you need help understanding digital asset income, contact NewWay Accounting. We can help you comply with tax laws and empower you to make smarter financial decisions. So, here’s to making the most of your digital currency investments, tax-smart style!