As the popularity and profitability of cryptocurrency continue to grow, it can leave taxpayers with an unexpected tax liability in April. It was estimated that there were more than 68 million crypto wallet holders in the United States at the end of 2021, a number too large for taxing authorities to ignore.
The IRS views cryptocurrency as a “Digital Asset,” and digital assets are treated as property for federal tax purposes. Taxable gains or losses may result from transactions involving digital assets, such as but not limited to; the sale of a digital asset, the exchange of a digital asset for property, goods, or services, and the receipt of a digital asset as payment for goods or services.
Determining your tax liability depends on your specific circumstances. For example, if you acquired a cryptocurrency from mining, the value of that cryptocurrency is taxable immediately as ordinary income. More importantly, you are permitted to deductions for all ordinary and necessary expenses paid, including the cost of electricity to operate mining equipment and the equipment itself. Similar to mining, staking allows an individual to earn rewards in the form of tokens. However, the IRS has issued guidance on crypto mining but has yet to release any guidance on staking. Many investors believe that staking is taxed the same as mining, but that is not always the case, as there are some gray areas. Investors have argued that they should not be taxed when they receive a coin as they are simply assisting in minting new coins. Instead, they believe that they should be taxed when it is sold. Given the different gray areas, it is important to talk to a tax professional and review your circumstances.
Cryptocurrency has some of the same tax consequences as stocks. When you buy and sell cryptocurrency, you will want to net your short-term capital gains with your short-term capital losses and long-term capital gains with long-term capital losses. Net short-term capital gains are treated as ordinary income and taxed at ordinary rates, while net long-term capital gains are treated as capital income and are taxed at capital rates of 0%, 15%, or 20%. If you have a net capital loss, it can help reduce your tax liability but similar to stock sales, the maximum amount of capital loss you can deduct in one year is $3,000, and the remainder will carry forward to the next tax year.
Unlike stocks, where you have a brokerage firm tracking your taxable activity throughout the year and providing you with a neat 1099-B summary form at the end of the year, it is uncommon for an exchange to issue a Form 1099-B, leaving you ultimately responsible for tracking your taxable activities. In the near future, crypto exchanges will be required to report to the IRS directly the crypto transactions as part of the bipartisan infrastructure bill signed into law by President Biden in November of 2021. The bill will require brokers to issue you a Form 1099-B. However, this applies to the 2023 tax year, leaving you responsible for tracking your activity for the 2022 tax year.
Currently, the only IRS guidance related to digital assets is; IRS Notice 2014-21, Frequently Asked Questions on Virtual Currency Transactions, Revenue Ruling 2019-24. Regardless of the size and complexity of your crypto portfolio, you should consider working with a CPA who has experience with virtual currencies, especially if you are someone dealing with a large amount of transactions, staking, or mining operations. Tax planning with a CPA can help you avoid an unexpected tax bill in April.