Investing in cryptocurrency is becoming increasingly mainstream and will likely become a permanent part of the U.S. financial ecosystem.  There are currently over 8,600 forms of cryptocurrency, with Bitcoin being by far the most popular, commanding over 68% of the market share.  Major retailers such as Microsoft, Home Depot, and Overstock are now accepting Bitcoin as payment for goods and services. 

For years, investors have avoided paying capital gains tax on cryptocurrency trades and sales.  This is due to the lack of financial reporting by cryptocurrency exchange brokers.  IRS Commissioner Charles Rettig estimates the annual “tax gap” to be $1 trillion, in part from unregulated cryptocurrency.  Congress is attempting to decrease the tax gap by expanding the reporting requirements for cryptocurrency transactions.  

On August 10, 2021, the Senate passed the Infrastructure Investment and Jobs Act.  As of the date of this writing, the bill still needs to be approved by the House and signed off by the President.  The bill contains a provision to expand reporting requirements for brokers of cryptocurrencies.  The expanded reporting is expected to generate $28 billion in tax revenue over the next 10 years. 

The proposed Act defines cryptocurrency as a digital asset which is a specified security.  Brokers of specified securities are required to provide customer information to the IRS including the customer’s cost basis and any gain or loss realized when the customer sells or exchanges the digital asset.  This expansion to include cryptocurrency as a specified security would go into effect for assets acquired on or after January 1, 2023.  If this bill is signed into law, you can expect to receive 1099 broker statements in early 2024 reporting your cryptocurrency gains and losses.  These gains and losses would be reported on your 2023 tax return.

Despite current absence of 1099 reporting, crypto transactions create taxable events that must be reported.

When do you owe taxes on your crypto?  Taxable events relating to cryptocurrency include the following:

  • Trading crypto for U.S. Dollar
  • Trading one crypto for another crypto
  • Using crypto to purchase goods or services
  • Mining crypto
  • Receiving crypto as a reward

How are crypto transactions taxed?  Here is what happens when cryptocurrency is traded or sold:

  • Gain or loss is realized from the trade or sale
  • The gain or loss is measured by the change in dollar value between the cost basis when the crypto is purchased and the proceeds received when the crypto is disposed
  • If the crypto was held for one year or less, the gain or loss is considered short-term and is taxed at ordinary income tax rates
  • If the crypto was held for more than one year, the gain or loss is considered long-term and is taxed at capital gains tax rates generally ranging from 15% to 23.8%, depending on your overall income

How can taxes on crypto gains be minimized?  Many of the tax reducing strategies available for publicly traded securities are also available for cryptocurrencies.  Some strategies are:

  • Engaging in Tax Loss Harvesting:  Sell cryptocurrency that has decreased in value to offset gains
  • Investing for the Long Term:  If possible, hold cryptocurrency for more than a year before selling at a gain to take advantage of lower long-term capital gains rates
  • Donating to Charity:  By donating appreciated digital assets directly to a charity, you avoid paying capital gains tax on the gain and enjoy a tax deduction equal to the fair market value of the cryptocurrency (assuming you itemize your deductions)

The world of cryptocurrency is still evolving, but rest assured that the experts at Ketel Thorstenson, LLP are here to help you along the way.  Please contact us with any questions or concerns.