Cryptocurrency (crypto) has turned from a novelty to an asset class that more and more Americans are considering for trading or investing. In 2021, about 13% of Americans traded in crypto (e.g., Bitcoin or Ethereum) in the preceding 12 months.
Like stocks or other asset classes, trading in crypto may trigger applicable taxable events. One of those taxes is the crypto capital gains tax.
However, not every transaction that you make with crypto ends up with this specific type of tax.
This guide will go over the Internal Revenue Service (IRS) treatment of cryptocurrencies, the definition of the crypto capital gains tax, a list of events triggering this tax type, and an overview of best practices.
How Does The IRS Treat Cryptocurrencies?
The Bitcoin network appeared on January 5, 2009. Back on January 16, 2009, about 100 daily confirmed transactions took place with Bitcoin. On January 14, 2014, that number skyrocketed to 61,612.
Due to fast cryptocurrency transaction growth, the IRS issued Notice 2014-21 on March 24, 2014, providing guidance on the tax treatment of virtual currency transactions.
On this notice, the IRS defined bitcoin and all other types of cryptocurrencies as virtual currencies. The IRS indicated that the sale or exchange of cryptos to pay for goods and services in the real world had tax consequences that could result in a tax liability.
For federal tax purposes, the IRS treats all types of virtual currency (like Bitcoin and Ethereum) as property. So, any cryptocurrency transaction is subject to the same tax implications as a property transaction.
In summary, whenever you sell crypto, your transaction may be subject to the crypto capital gains tax.
What Is The Crypto Capital Gains Tax?
The capital gains tax is a government charge when you sell a property for profit.
For example, if you were to buy stock for $50,000 and sell it for $60,000, you would make a $10,000 profit. The $10,000 profit from the sale is a taxable capital gain. You would owe the applicable capital gains taxes on those $10,000.
The capital gains tax applies to a wide range of items that are deemed properties, including stocks, homes, art pieces, and cryptocurrencies.
The crypto capital gains tax is a term that specifies that the capital gains tax applies to crypto. The crypto capital gains tax is the capital gains tax you pay when you sell any cryptocurrency for a profit.
How do I determine crypto capital gains?
To determine if you owe a capital gains tax, you need to first determine if you have capital gains.
Depending on the difference between your crypto’s purchase price (also known as cost basis or cost base) and its sales price, you may incur a capital gain or a capital loss.
Remember that you can include in your cost basis any expenses and fees that you incurred to purchase the crypto. Use the fair market value of your crypto at the time of purchase to set your sales price.
Sales price (fair market value) - cost basis (including expenses and fees) = capital gain or loss. Let’s break this down a bit more.
If you sell crypto at a price higher than you bought it, then you have a capital gain. In this case, you owe a crypto capital gains tax.
In this example, the cost base of the Bitcoin is $10,000, and the fair market value is $12,000.
$12,000 - $10,000 = $2,000 capital gains.
You would owe applicable capital gains tax on the $2,000 of capital gains in this case.
If you sell crypto at a price lower than you bought it, then you have a capital loss. In this scenario, you don’t owe capital gains tax.
In this example, the cost base of the Ethereum is $1,200, and the fair market value is $1,000.
$1,200 - $1,000 = $200 capital losses.
All things equal, you wouldn’t owe capital gains tax on the $200 of capital losses.
What happens to capital gains tax when I have several crypto transactions?
When you have more than one sale of cryptocurrency, you can use a capital loss to offset a capital gain.
Let’s combine the two previous transaction examples:
Transaction 1: $12,000 - $10,000 = $2,000 capital gains
Transaction 2: $1,200 - $1,000 = $200 capital losses
Net capital gains: $2,000 - $200 = $1,800
By combining both transactions, you would only owe capital gains tax on $1,800.
What Are The Different Types of Crypto Capital Gains Taxes?
The two types of crypto capital gains taxes are short-term capital gain taxes and long-term capital gains taxes.
The rate on cryptocurrency gains depends on the time that you hold the crypto:
- A crypto short-term capital gains tax applies when you sell crypto after having it for less than a year (365 days and under).
- A crypto long-term capital gains tax applies when you sell crypto after one year (366 days and above).
Crypto short-term capital gains taxes
When you hold a crypto asset for 365 days or less, you incur short-term capital gains or losses at the time of sale.
The crypto tax rate for short-term crypto gains depends on your reported income and tax filing status (e.g., single filer, joint filer). Typically, single filers pay higher short-term capital gains taxes than joint filers.
In 2022, the rate on cryptocurrency gains of 365 days and under ranges from 10% to 37%.
State short-term capital gains taxes vary. You should consult your state’s tax office for more details.
Example of crypto short-term capital gains tax
Let’s assume that you and your spouse are married filing jointly in 2022 with a total adjusted income of $179,000.
During that year, you buy Bitcoin cash for $1,000 and sell it two months later for $1,300. You incur a short-term capital gain of $300.
Your applicable short-term capital gains tax rate is 24%. In 2022, you would pay $72 ($300 x 24% = $72) in crypto capital gains tax.
Crypto long-term capital gains taxes
Long-term capital gains rates apply to crypto sales with a holding period of 366 days and more. The IRS taxes long-term gains at a lower rate than short-term gains.
The crypto tax rate for long-term crypto gains also depends on your reported income and tax filing status.
In 2022, long-term crypto capital gains tax rates range from 0% to 20%.
If your adjusted income falls below the defined threshold, you don’t pay any crypto taxes on capital gains.
State long-term capital gains taxes vary. You should consult your state’s tax office for more details.
Example of long short-term capital gains tax
Let’s assume that you’re a single filer in 2022 with a total adjusted income of $72,000.
Two years ago, you purchased Ethereum for $300, and this year you decided to sell it for $1,000 this year. You have a long-term capital gain of $700.
Your applicable long-term capital gains tax rate is 15%. In 2022, you would pay $105 ($700 x 15% = $105) in crypto capital gains tax.
In this scenario, notice that the applicable long-term cryptocurrency tax rate (15%) is lower than that if you had held the crypto for less than 365 days (22%).
What Are Taxable Events That Trigger a Crypto Capital Gains Tax?
Not every crypto transaction triggers a crypto capital gains tax.
For example, buying crypto with cash isn’t a taxable transaction. As long as you hold the crypto and don’t sell it, you won’t pay a crypto capital gains tax.
Here’s a list of events that trigger crypto capital gains taxes:
- Selling cryptocurrency for cash (also referred to as “fiat”)
- Using cryptocurrency to pay for goods or services (e.g., buying a pizza with Bitcoin, paying a freelance graphic designer with Ethereum)
- Trading one type of cryptocurrency for another (e.g., buying Bitcoin cash with Dogecoin)
Some events that don’t trigger crypto capital gains tax include:
- Buying cryptocurrency with fiat currency (cash)
- Receiving cryptocurrency for payment for goods or services
- Donating crypto to eligible charitable organizations
Do I Pay Crypto Capital Gains Taxes When Gifting Crypto to My Children?
Crypto gifts below $15,000 to your children aren’t subject to gift taxes. In 2022, the gift tax deduction of up to $15,000 also applies to crypto donations. The crypto capital gains tax would trigger only if you or your child sell the cryptocurrency.
Should I consider putting crypto in my kid’s investment accounts?
Yes, you should include crypto in your kid’s investment plan.
Crypto, including Bitcoin and Ethereum, is an option for diversifying your child’s investment plans and ensuring that they are equipped for the future economy.
For more info on investing in cryptocurrency for children, check out our guide to crypto for kids.
Are There Other Crypto Taxes?
Yes, there are other cryptocurrency taxes besides the crypto capital gains tax.
Since 2021, the IRS wants to know if you have completed any type of virtual currency (crypto) transactions.
In 2022, you pay your applicable income tax rate for the following activities. (Disclaimer: this is not accounting advice, and we’re not accounting professionals. Consult your tax professional for more details).
Receiving cryptocurrency for payment for performing goods or services
While you don’t pay crypto capital gains tax for receiving crypto payments, you need to include those payments as income in your tax return.
You would use the fair market value at the time of payment to determine the value of your crypto.
Earning interest from a decentralized finance lender (DeFi lender)
Some financial institutions give you interest payments for making deposits in a savings account. These types of savings accounts pay a higher savings rate than those of regular banks.
The reason those financial institutions are able to pay higher rates is that they make trades and investments in crypto. While your deposits and interest payments are in cash, your funds are put into crypto investments.
Typically, you would report this interest as interest income in your income tax return.
Earning crypto from staking and liquidity pools
“Staking” crypto is the process of earning interest on your crypto without selling it. Unlike the previous scenario, in this scenario, you’re directly using your own crypto holdings.
You should also declare interest payments from staking as interest income.
Earning crypto from mining crypto
“Mining” is the term for creating new crypto by verifying crypto transactions. Crypto miners receive crypto as a reward for their mining expenses.
The IRS taxes crypto mining income the same as other income.
Best Practices For Crypto Capital Gains Tax
If you use or plan to make crypto transactions, you need to have a plan. The key to success with the crypto capital gains tax is to keep good records.
Let’s review a few good bests practices:
- Include crypto transactions in your return: Since 2021, the IRS has included a question about virtual currency transactions in Form 1040. If you don’t include your crypto transactions in your return, the IRS may consider this omission as tax evasion. An understatement penalty may range from 20% to 75%, depending on several factors.
- Collect forms whenever possible: Crypto exchanges often issue you a 1099-K when you have over 200 transactions and $20,000+ in trading per year. Some exchanges may issue a 1099-B when you sell crypto above a certain threshold. Other exchanges may not issue any tax forms at all.
- Keep and reconcile transaction records: It’s a good practice to keep records of your transactions. Additionally, most exchanges will provide you with a digital record of your transaction records. This transaction record is often a CSV or Excel file. Use this transaction record to reconcile against your own record of crypto transactions.
- Take advantage of tax-loss harvesting: Remember that you can offset capital gains with capital losses. If you have a large capital gain balance in a year, you may decide to sell some crypto at a loss to minimize taxes.
- Remember that long-term capital gains tax is lower: Strive to hold crypto for a minimum of 366 days before selling it. The long-term capital gains tax rate is lower than its short-term counterpart.
- Consult your tax professional about the crypto capital gains tax, and familiarize yourself with IRS Form 8949.
As a new asset class, crypto is still evolving and is subject to volatility. Still, as Americans continue to adopt cryptocurrencies, you should consider allocating a portion of your portfolio to Bitcoin and other cryptocurrencies.
Crypto is not only an option for diversifying your investment but also ensuring that your child is equipped for the future economy.
EarlyBird Crypto will let you gift crypto to a child. Currently, the full functionality of EarlyBird Crypto is still in development. However, you can claim Early Access and open your child’s wallet with a $25 sign-up bonus on us.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.