Do you own or plan to own cryptocurrency? If so, you need to understand how it will impact your tax bill!
A quick look at how cryptocurrency taxes work:
The Internal Revenue Service (IRS) treats all cryptocurrency as capital assets, and taxes them when they’re sold at a profit. Capital gains tax rules apply to cryptocurrencies.
What this means, essentially, is that when you buy something from your Bitcoin, let’s say, it’s not as straightforward as a normal transaction. If the Bitcoin has gained value since you purchased it, which it likely has if you’ve had it for a while, it’s like selling your Bitcoin at a profit, in exchange for some goods.
If, however, your crypto investment LOST value and you sold it for dollars, purchased something, or exchanged it for another cryptocurrency, you faced a capital loss. And you don’t owe any taxes for that.
And not only do you not owe any taxes for a capital loss — you may also be able to USE a capital loss to offset other income taxes. Be sure to ask your tax preparer for that, if applicable!
How long you’ve held crypto matters:
Your tax bill depends on both how long you’ve had the cryptocurrency you do and also what your overall annual income is!
If you’ve had the Bitcoin for a year or even less, profits would be considered short-term capital gains, and these are taxed at your regular income tax rate.
If you’ve held your cryptocurrency for more than a year, profits are considered long-term capital gains. These are taxed at a LOWER rate than most income taxes, depending on what your annual income is.
If you mine cryptocurrency or receive it as a payment, it is considered a part of your regular taxable income. You owe tax on the value of the crypto the day you receive it, at your regular income tax rate.
And if you then hold the cryptocurrency mined or earned, its value increases, and you then spend it or sell it at a profit… yes, you would also owe capital gains taxes on those profits.
Phew. So now that that’s out of the way, let’s take a look at how you can file your 2020 crypto taxes.
The FIRST question on the new 2020 Form 1040 is about virtual currency transactions.
If your answer to this question is yes, or is going to be yes in future, here’s what to remember:
1. Keep records of ALL transactions
Make sure you track all crypto transactions. This includes how much you paid for it, how long you’ve had it for, how much you sold it for, as well as all receipts.
If you’re trading cryptocurrency thousands of times a year, this can be challenging to track and more challenging to report on your tax return. But this is something to keep in mind.
2. Use software to track your transactions
If you’re using an investing platform or exchange that keeps track of your cryptocurrency transactions, you’re all set. But if you don’t, you still have options.
There are new software companies that will “scrub” the blockchain to detect transfers between your wallets, and they can generate reports related to the wallets — within a given tax year.
3. Fill out the right tax forms
Once you’ve gathered a complete record of all transactions, you’ll need to fill out tax forms depending on how you’ve used crypto. Here are some forms that might apply to your situation:
Form 8949: This form logs every purchase or sale of crypto as an investment. Include the total number of coins, when you bought it, how much you bought it for, and when and how much you sold it for — as well as your net gain or loss per transaction.
Schedule D: This form recaps your total capital gains and losses from all investments, which includes crypto.
Schedule C: You will need to disclose whether you received coins as a business or a hobby if you received them from mining. If you’re running a mining business, report your income on this form, and subsequently deduct any expenses.
Schedule 1: If you report your crypto mining activities as a hobby, report any income on line number 8 of this form. This limits what you can deduct as an expense, but you won’t owe any self-employment tax.
4. File your taxes
You probably saw this one coming.
If you keep records in a software, you can probably connect them with an online tax software, and then use that to file your returns.
5. Hire a professional
As you may have realized by now, preparing for crypto taxes can be complicated. Since crypto is still new, laws around cryptocurrency and its taxes are ever-changing. If you’ve made a sizable income from crypto, it can definitely be worth it to have a professional on your side.
If you can’t or don’t want to hire a professional though, here are some tips we have for you to cut down your crypto taxes:
1. Hold crypto for more than a year
If you’ve held onto your crypto investment for at least one year before you sell, your gains qualify for the long-term rate. Depending on your annual income, this can cut your tax rate by almost half, from a maximum of 37% for short-term to a maximum of 20% for long-term gains!
2. Offset your gains with losses
Like other investments, you can take advantage of crypto gains by claiming losses on other investments in the same year. So if you made $15K by selling one cryptocurrency, but lost $15K selling another… you will have broke even, and won’t owe any taxes!
3. Claim mining expenses
Mining crypto can add up, in equipment, electricity, and ISP charges. If you mine crypto, you can deduct these costs against your income, although the exact amount will depend on whether you considered crypto a business or a hobby.
4. Use a retirement plan!
What if we tell you you can defer or altogether avoid investment gains entirely? You can do exactly that, if you invest in crypto using a retirement plan like a traditional IRA or Roth IRA.
However, this is not that common and certainly not that easy to do.
If you’re looking to pay less in taxes, donate a portion of your crypto profits to charity. You’ll get a deduction worth the FULL value of your crypto — including gains.
Cryptocurrency is in the limelight right now, partly due to Elon Musk and his support pushing Bitcoin’s price sharply higher recently. Have you invested in cryptocurrency?
If you have and you’re overwhelmed by it, we are here to help. Whether you need advice or you wish to book a FREE tax preparation appointment, Evolution Tax Center is here for you.
Book a free appointment HERE!
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