Understanding the impact of cryptocurrency investments on taxation is crucial in today’s digital world, especially with the Internal Revenue Service (IRS) classifying cryptocurrency holdings as “property” for tax purposes. Consequently, any sale or disposal of cryptocurrency for another digital asset must be reported on your tax return.

The common misconception is that not trading crypto back to United States Dollars (USD) means no taxes on gains. However, grasping how cryptocurrency transactions are taxed is vital for anyone involved in the crypto world. This article will delve into the major classifications of crypto transactions and how they affect your taxation.

What cryptocurrency transactions are subject to taxation?

Buying Cryptocurrency

Buying cryptocurrency with fiat is usually not taxable. However, those with significant crypto holdings in foreign exchanges may need to complete informational forms.

Purchases (Sending crypto for goods and services)

Making purchases of goods and services with cryptocurrency, such as coffee, groceries, tour services, etc., is treated like selling coins for fiat and then using the fiat to make the purchase.

Selling Coins (Crypto to Fiat)

Selling coins can trigger taxes on capital gains and losses. Tax rates on capital gains are often lower than on ordinary income. Tax Loss Harvesting (TLH) is an advanced strategy to offset capital gains with the losses on underperforming coins. TLH is frequently used by users towards the year-end.

Trades & Exchanges (Crypto to Crypto)

Cryptocurrency trading and exchange can trigger capital gains taxes. The IRS treats crypto to crypto trades as a sale followed by a buy, similar to how stocks are treated. The sale is taxable, while the buy is not.

Self-Transfers

When you move your cryptocurrency holdings between your accounts, there will be no effect on your capital gains or income taxes. However, if you plan to transfer a substantial amount of your holdings from a US-based exchange to a foreign one, you may need to file an informational report for foreign holdings.

Mining/Staking Rewards

Any reward received is considered miscellaneous income and must be reported on Form 1040. This income is subject to regular income tax rates.

Interest & Dividends

When filing taxes, crypto earnings should be reported on Schedule B of Form 1040, similar to regular interest and dividends. Since smaller or international crypto exchanges might not issue 1099 forms, utilizing crypto tax software can greatly assist in maintaining accurate records.

Wages/Payment for services rendered (Receiving crypto for goods and services)

You must treat payments received in cryptocurrency through wages like traditional fiat currency wages. These payments will be considered taxable income and must be reported on your tax return. On IRS Form 1040, you can include them as wages or as income under Schedule C.

Airdrops

Regardless of their distribution method, airdrops are subject to taxation as ordinary income. The tax liability associated with an airdrop is determined by the value of the received cryptocurrency on the date of its receipt.

Hard Fork

In cases where a hard fork is followed by an airdrop of the newly created coin, the coins obtained through the airdrop may be subject to taxation.

Soft Fork

When forks involve soft forks, the distribution of additional coins through airdrops does not typically occur. So, there is no tax implication.

Gifts Sent

When giving cryptocurrency as a gift, the same tax guidelines apply as for other property and fiat currency. There is no need to recognize gain or loss. Each donor can gift $15,000 (double for a married couple filing jointly) per recipient per year without incurring gift tax.

Gifts Received

Gifts of virtual currency are subject to tax for the receiver once the coins are sold. The cost basis for the sale will depend on the basis of the sender, the gift tax paid by the sender, and the fair market value (FMV) on the date of the gift.

Donations

Donating coins to charities can provide significant tax benefits. You won’t have to pay taxes on any income, gain, or loss associated with those donated coins.

Foreign Holdings

Holdings in foreign exchanges, such as Kucoin, may be subject to reporting on various forms, such as FATCA Form 8938, FinCEN 114, and IRS FBAR forms.

In conclusion, understanding the taxation of cryptocurrency investments is vital. Please consult a tax professional to ensure compliance with all relevant tax laws and regulations.