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Taxes on cryptocurrencies: A guide to the tax rules for bitcoin, ethereum and more

Given the rapid rise and fall of some cryptocurrencies like Bitcoin and Ethereum, crypto traders may have serious tax issues on their minds.

The Internal Revenue Service (IRS) is ramping up its efforts to enforce tax laws, and even those who hold cryptocurrencies - let alone trade them - need to make sure they don't run afoul of the law.

That might be easier than you think, given how IRS treats cryptocurrencies.

"It's a really big area of enforcement for the IRS right now," says Brian R.

Harris, tax attorney with Fogarty Mueller Harris, PLLC in Tampa. "They're generating a lot of publicity by going after people who own, trade or use cryptocurrencies.

These people can be a target for audits or compliance reviews.

For example, while one of Bitcoin's selling points was its anonymity (or at least semi-anonymity), regulators have caught on with some success in recent years.

" IRS and FBI are getting better at tracking and tracing Bitcoin in criminal investigations," Harris says. And they can freeze assets if needed, he adds.

That makes it all the more important for those trading the popular cryptocurrencies to know the laws and what taxes could be incurred by their actions.

The good news: the IRS generally treats cryptocurrencies similarly to other investments such as stocks and bonds. The bad news: this treatment makes it difficult to use cryptocurrencies to purchase goods and services.

Here are some important things to know about cryptocurrency taxes and how to stay on the right side of the law.

Topics covered on this page:

• You'll be asked if you own or use cryptocurrency
• You won't escape taxation just because you didn't receive a 1099
• Just using cryptocurrencies exposes you to potential tax liability
• Profits from crypto trading are treated like regular capital gains
• Crypto miners may be treated differently than others
• A gift of cryptocurrencies will be treated like other gifts
• Inherited cryptocurrencies will be treated like other inherited assets
• The "wash sale" rule doesn't apply to cryptocurrencies 8 important things to know about crypto taxes 1. You'll be asked if you owned or used cryptocurrencies

8 important things to know about crypto taxes

1. You’ll be asked whether you owned or used cryptocurrency

On your 2022 tax return, you'll need to indicate whether you traded cryptocurrencies. Form 1040 clearly asks, "At any time during 2022, did you receive, sell, ship, exchange, or otherwise acquire a financial interest in any virtual currencies?"

So you definitely have to answer whether you've traded cryptocurrencies, which puts you in a position to potentially lie to the IRS. If you don't answer honestly, you could find yourself in further legal trouble, and the IRS isn't very friendly to liars and tax cheats.

However, there's a footnote. In a clarification, IRS states that taxpayers who've only purchased virtual currency with real currency aren't required to answer "yes" to the question.

2 You don't escape tax liability just because you didn't receive a 1099.

With a bank or broker, you (and the IRS) usually receive a Form 1099 that lists the income earned during the year. However, this may not be the case with cryptocurrencies.

 "The IRS doesn't get great reporting from Coinbase and other exchanges."

However, a November 2021 law will require more tax reporting for those in the industry starting Jan. 1, 2023. The law requires brokers - and that controversially includes anyone who moves digital assets for others - to report that information on a 1099 or similar form to IRS.

Opponents say the law would require anyone who moves cryptocurrencies, including miners and crypto wallets, to follow the new rules, even those who don't have access to that information. However, lawmakers are already working on a new bill to more precisely define who the law applies to.

However, not having a 1099 certificate won't exempt you from tax liability, and you'll still have to report and pay taxes on your winnings. But there's good news: if you took a capital loss, you can deduct it on your tax return and reduce your taxable income.

3. just by using cryptocurrencies, you're exposed to potential tax liability.

You might think that if you only use cryptocurrencies but don't trade them, you're not liable for taxes.

This isn't true!

Any time you exchange virtual currencies for real currencies, goods, or services, you may incur a tax liability. A tax liability arises when the price you get for your cryptocurrency - the value of the good or real currency you receive - is higher than your cost basis in the cryptocurrency. So, if you receive more value than you invested in the cryptocurrency, you'll incur a tax liability.

Of course, if the value of the goods, services, or real currency is less than your cryptocurrency cost basis, you may also incur a tax loss.

In any case, you need to know your cost basis in order to make the calculation.

It is important to note that this is not a transaction tax.It is a capital gains tax - a tax on the realized change in the value of the cryptocurrency. And like stocks that you buy and hold, if you do not exchange the cryptocurrency for something else, you have not realized a gain or loss.

4.Profits from crypto trading are treated as regular capital gains.

So you have realized a profit from a profitable trade or purchase? The website IRS generally treats gains from cryptocurrencies the same as any type of capital gain.

That is, you pay  tax rates on short-term capital gains (up to 37 percent in 2022, depending on your income) for assets held for less than a year. However, for assets held longer than one year, you pay a long-term capital gains tax, probably at a lower rate (0, 15, and 20 percent).

And the same rules for offsetting capital gains and losses apply to cryptocurrencies. So you can deduct capital losses and realize a net loss of up to $3,000 each year. If your net losses exceed that amount, you must carry them over to the next year.

5. crypto miners may be treated differently than others

Do you mine cryptocurrencies as a business? If so, you may be able to deduct your expenses like a typical business. Your income is the value of what you produce.

"If it's a trade or business, your expenses may be deductible.

But that last part is the key point: You have to be engaged in a trade or business to qualify. You can not operate your mining equipment as a hobby and claim the same deductions as an actual business.

6. a crypto gift is treated like other gifts.

If you gave cryptocurrency as a gift to someone, perhaps a younger relative to spark interest, your gift will be treated the same as any other similar gift. So it may be subject to gift tax if it's over $16,000 in 2022. And if the recipient sells the gift, the cost basis remains the same as the donor's cost basis.

However, there are some ways to avoid gift tax even if you exceed the annual threshold, such as using the lifetime exemption amount.

7. Inherited cryptocurrencies are treated like other inherited assets.

Inherited cryptocurrencies are treated like other capital assets that are passed from one generation to the next. They may be subject to estate tax if the estate exceeds certain thresholds ($12.06 million in 2022).

As with stocks, the acquisition value of cryptocurrencies is increased to the fair market value on the date of death. So, in general, cryptocurrencies are treated like a typical asset for most people, Harris says.

8. the " wash sale" rule does not apply to cryptocurrencies.

While the IRS largely treats cryptocurrencies like capital assets, it takes a completely different approach when it comes to wash sales. And this is actually beneficial for crypto traders.

Typically, a trader who sells an asset and reports a loss must not have purchased that asset (or one very similar to it) within 30 days before or after the sale. If the dealer repurchases the asset within that 30-day window, it is declared a wash sale. Thus, the loss cannot be claimed as a write-off until the dealer no longer purchases the asset, at least within the 30-day window.

For cryptocurrencies, however, this " wash sale" rule does not exist. So, traders can sell their position, record a loss, and buy back the asset literally moments later and still claim the loss. This rule is beneficial because it allows traders to capture the full value of the tax loss while still invested, meaning it is risk-free to actually claim the tax write-off.

However, lawmakers have discussed closing this loophole, so it may not be around much longer.

Conclusion

It can be surprisingly burdensome to actually use cryptocurrencies, from tracking the cost basis to determining the actual price realized to potential tax liability (even without an official 1099 certificate). In addition, IRS is stepping up enforcement and monitoring of potential tax evasion by taking a closer look at who is exchanging cryptocurrencies. All of these factors contribute to discouraging the use of cryptocurrencies and likely slowing their further proliferation.