Cryptocurrencies are popular for many reasons, and a prominent one is that it does not have any authority over it. This lack of jurisdiction also leads to a lot of confusion as many people don’t know whether cryptocurrencies are taxable or not.
After all, they aren’t any government’s currency. Still, when you’re a resident of a country, and you make monetary transactions with cryptocurrencies, you might need to pay taxes on those transactions.
In this article, we’ll be tackling how cryptocurrencies are calculated and help you understand whether you need to pay taxes on your cryptocurrencies or not.
What are Cryptocurrencies?
Digital currencies that you manage and create through cryptography are called cryptocurrencies. They entered the market in the year 2009 in the form of Bitcoin. They are decentralized, which means there’s no central authority that governs them.
As they are decentralized, they have a peer to peer technology that handles all the operations, including the processing of transactions as well as issuing of more currency. For example, to get Bitcoins, you’ll need to perform mining. Mining requires you to use highly powerful computers and complicated algorithms to get bitcoins.
So, Bitcoins are different from Fiat currencies as the latter relies on the government for their supervision. The government produces and manages those currencies.
Moreover, Fiat currencies don’t have any limit on their production; the government can produce as much of them as required. Bitcoins, on the other hand, are limited. Its value depends on what the investors want to pay for it, nothing else.
Cryptocurrencies and Tax
The IRS treats cryptocurrencies just like it treats gold or real estate. That means it treats the cryptocurrencies like property. This also means that cryptocurrencies can fall under long-term and short-term capital gains tax.
You’d need to pay long-term capital gains tax if you held the cryptocurrencies for a long duration. Similarly, you’ll need to pay short-term capital gains tax if you held it for a short period.
When Cryptocurrencies are Taxable
As the IRS treats cryptocurrencies like property, you’ll have to pay taxes on them whenever you trade one for the other. Trading of cryptocurrencies is taxable whether the trade is for another cryptocurrency or for fiat currency. To know how much tax you’ll have to pay for such a trade, you’ll have to calculate its market value in USD at the trade’s time.
Also, the IRS doesn’t waste its time. If you fail to report your income from a crypto transaction (such as a sale), you’d be liable to pay interest and penalties on the unpaid taxes. Suppose you paid bitcoin to purchase a car, in this scenario, you’ll have to pay taxes.
When Cryptocurrencies are Not Taxable
Cryptocurrencies aren’t taxable in every situation. There are possibilities where you aren’t liable to pay any taxes to the IRS. If you transfer cryptocurrency as a gift, you wouldn’t need to pay taxes on the same as long as the amount is under the gift tax exemption limit.
Transferring cryptocurrency between wallets is another tax-free event. You can transfer your cryptocurrency from one wallet (or exchange) to another without worrying about the capital gains tax. If you donate your cryptocurrency to a qualified tax-exempt non-profit or charity, you wouldn’t have to pay taxes on this transaction.
The purchase of cryptocurrency with Fiat currency is not taxable as well. You won’t have to pay tax as long as you don’t use, sell, or trade your cryptocurrency.
However, if you hold it for more than a year, you’ll be liable to pay long-term capital gains tax. You should know that losses on cryptocurrencies are deductible from your tax.
How to Pay Cryptocurrency Taxes
To pay cryptocurrency taxes, you’ll need to calculate them first. As their values keep fluctuating from time to time, you should use cryptocurrency tax software to help you in this regard.
You’ll have to calculate every transaction you made through cryptocurrencies to see whether you incurred losses or gains. You’ll need to perform a thorough review of every transaction for this purpose.
Make sure that you use a proficient calculator for this purpose because any mistake in this regard can lead to unpaid liabilities you could’ve avoided. It also helps you in filing tax forms such as Schedule D and 8949.
How is Tax Calculated on Cryptocurrencies?
You already know that transactions of cryptocurrencies are liable for capital gains taxes. To calculate the capital gains tax, you should first subtract the purchase price of the cryptocurrency from the selling price. It’s fundamental, but it can get quite tricky as you’ll have to calculate the taxes on every transaction you make.
You should use FIFO or LIFO for calculating the taxes on your transactions. FIFO stands for First In First Out. According to this, you’ll assume that the coins you had bought first would have been sold first as well.
So, for example, if you bought 2 BTC, the first one in 2017 for $2,000 and the second one in 2018 for $2,500. Let’s suppose you sold one of them for $3,000 later. According to FIFO, the cost basis of this transaction would be $1,000, so the profit would be:
$3,000 (selling price) – $2,000 (cost basis) = $1000 (profit)
You will need to give capital gains tax on the $1,000 profit you made in this transaction. LIFO, on the other hand, stands for Last In First Out and considers that you’d have sold the last coin you bought first.
By using a cryptocurrency tax calculator, you can avoid mistakes and get the exact amount you are liable to pay. Such calculators simplify the calculation process and help you in filing the taxes as well.
With the help of tax calculation software, you can reduce your hassles and calculate the taxes on your transactions easily. There are many useful tax calculation software such as Zenledger that make every step of your transaction and tax-paying smooth. Remember to conduct thorough research regarding the credibility, bandwidth, and the versatility of the software that you choose.