Trading cryptocurrency can be an excellent way to generate profits, but you should understand its tax repercussions before engaging. The IRS considers cryptocurrency to be property, so any time you sell or exchange them for other assets you must pay taxes accordingly.
For instance, when trading one cryptocurrency for another, it is necessary to calculate its fair market value in order to ascertain any capital gains or losses and record any cost basis adjustments accordingly.
Capital Gains Tax
Cryptocurrency is considered property by the IRS, making its sale subject to capital gains taxes when sold. When asset holding periods of less than one year end, profits are taxed at short-term capital gains rates while long-term rates depend on an individual taxpayer’s income level.
Taxpayers who invest in cryptocurrency must maintain detailed records of all their cryptocurrency transactions to calculate an adjusted gross income for every year they invest. Furthermore, they should be prepared to explain how they calculated capital losses or gains should they ever face an audit from the IRS.
Keep meticulous records when trading cryptocurrency through decentralized exchanges or directly peer-to-peer, since these types of transactions are more difficult for tax administrators to monitor than more easily regulated exchanges. Reporting requirements could force users away from decentralized ones altogether and toward those more easily controlled like centralized exchanges that offer better controls.
Dividends
Once dismissed as the domain of tech enthusiasts, cryptocurrency has grown immensely popular with mainstream society and trillion dollar valuations. Proponents claim it serves as an alternative form of finance; however, the IRS keeps tabs on crypto trading and investment just like it would any other source of income; to prevent unpleasant surprises come tax time you should be more organized during the year and ensure all crypto transactions are recorded properly.
Investors who believe cryptocurrencies represent the future and expect their price to increase can purchase and hold, or they can trade CFDs (contracts for difference) to take advantage of market fluctuations without actually becoming owners of any coins. Trading cryptocurrency exposes investors to various risks such as management risk, programming risks and market manipulation; additionally the price can fluctuate wildly daily or even hourly depending on underlying assets such as bitcoin or another cryptocurency asset.
Withholding Taxes
Trading one cryptocurrency for another should be reported as ordinary income. Your profit or loss depends on its fair market value when trading against fiat currency; similar principles apply when exchanging crypto for fiat.
Trading Bitcoin for USD is treated as the sale of property for tax purposes and the proceeds must be taxed accordingly. Furthermore, the IRS requires traders to accurately calculate their cost basis; your exchange may help with this calculation; but if not they must maintain accurate records themselves.
One common error made by crypto traders is believing the IRS cannot see their transactions, thus negating the need to report them on their taxes. Unfortunately, this assumption can have serious repercussions, including audits, interest charges on unpaid taxes and criminal prosecution. Keeping accurate records is crucial in order to avoid penalties such as these.
Reporting to the IRS
The Internal Revenue Service treats cryptocurrency as property and taxes any gains from trading or disposing of that property. When selling crypto assets, they should be reported and calculated into capital gains/losses using both original cost basis and fair market value at sale time.
Taxpayers who exchange one crypto asset for another must report these transactions and calculate gains or losses based on their original cost basis of the new coin purchased, and its fair market value when sold. Staking rewards received via proof-of-stake networks also constitute taxable income in the United States and taxpayers must keep records to accurately track these payments.
Some cryptocurrency brokers rely on the anonymity of blockchain to skirt reporting requirements and the IRS’ accuracy penalties, so Treasury and IRS officials should act swiftly to provide guidance that clarifies how existing laws governing income recognition and reporting apply to cryptocurrency trading.
