How to Calculate Crypto Capital Gains Taxes

What Kind of Crypto Taxes Do You Pay in the U.S.?

Citizens of the U.S. pay taxes on cryptocurrency pro?ts. Taxes on short-term capital gains and income from cryptocurrencies can reach a high as 37%, while long-term capital gains are taxed at a maximum of 20%. In the U.S., cryptocurrency is comparable to a stock or an investment property. Because digital assets such as Bitcoin, Ethereum, and other cryptocurrencies are seen as property, it is possible that either Income Tax or Capital Gains Tax will apply in some scenarios. We will examine both after gaining knowledge of how the Internal Revenue Service keeps an eye on your cryptocurrency dealings.

How Does the IRS Track Crypto?

Here’s how IRS knows about your crypto investments-

1. Your information is collected and made accessible to the IRS by way of KYC (Know Your Customers) checks all major crypto exchanges must complete.
2. Exchanges keep track of banking information where they provide crypto in exchange for ?at payments.
3. Many exchanges maintain a record of crypto addresses you withdraw funds to, meaning they can identify custodial wallets.
4. Many exchanges send 1099 forms to the IRS and users.
5. The IRS has fought and won cases against Kraken, Poloniex and Coinbase, compelling them to share customer data.

In a nutshell, the IRS is aware of the situation, so there is no way to avoid paying taxes on cryptocurrencies.

When Do You Pay Capital Gains Tax on Cryptocurrency?

The events associated with paying capital gains tax on cryptocurrencies are:

1. Selling cryptocurrency for ?at money (U.S. Dollar, Japanese Yen, etc.)
2. Purchasing goods and services in exchange for cryptocurrency, even if you buy a pizza.
3. Trading or swapping digital assets, including purchasing NFTs with crypto.

Take note that taxes should only be paid on any profits that are earned due to one or more of these activities, not on the full sum of assets that were sold. The taxable capital is the amount of money made on an asset, taking into account the cost of purchase and the price at which it was sold. It is essential to remember that the Internal Revenue Service has yet to provide precise regulations on whether or not making tokens, fabricating wrapped tokens, minting NFTs in public or minting interest-bearing assets are liable to taxation. It is not known if exchanging LP tokens in decentralized finance liquidity pools to either take out or put in liquidity is a transaction between two different cryptocurriencies. It is recommended that you consult with a tax expert if you have taken part in any cryptocurrency activities during this tax year.

How Are Capital Gains Tax on Crypto Calculated?

A number of elements decide the rate of taxation you owe on your capital gains. This encompasses how long you retain your digital currency, how you are filing tax returns, and what you make.

As far as the IRS is concerned, the amount of time one holds onto cryptocurrency begins when it is bought and finishes when it is sold. The duration is based off when it was bought, not when it was sold. Hence, it is critical to recall when your possessions were purchased.

Short-term Capital Gains on Crypto

For the 2022 fiscal year, the short-term capital gains rate will be the same as the ordinary income tax rate and will vary depending on the taxpayer’s tax bracket.

The federal marginal income tax rate at its lowest point is 10%, whilst the highest rate of taxation is 37%. The amount of taxes you pay on your wages is based on the annual salary you make.

The Internal Revenue Service views any profits made through investing in cryptocurrencies as supplemental or extra income to be combined with a person’s regular earnings. Let’s say, for instance, that if you were filing taxes as a single person, you would have earned $100,000 in wages plus an extra $20,000 from short-term cryptocurrency investments. In this case, your combined taxable income is $120,000.

The Internal Revenue Service (IRS) divides income for tax purposes into different categories where different parts of the income are taxed differently. The initial $9,950 of your wages is subject to the minimum marginal rate of 10%, which means that 10% of $9,950 will be deducted for taxes.

The next range of income from $9,951 to $40,525 will be subject to a 12% tax rate. The first $40,526 – $86,375 of income is taxed at a rate of 22%, and any income above $86,376 up to $164,925, including the $20,000 gained through crypto capital gains, is taxed at a rate of 24%.

Long-term Capital Gains on Crypto

If you do not dispose of your cryptocurrency until after it has been held for more than 12 months, you will be subject to long-term capital gains taxes.

For the 2022 reporting season, what rate will you pay in long-term capital gains taxes? This will depend on your taxable income and filing status, and could range from 0% to 15% to 20%. The Internal Revenue Service (IRS) makes it so that the rate of taxation for long-term investments is lower than the rate for short-term investments, as they view the former as less risky.

After about eighteen months, you and your partner decide to cash out your cryptocurrency in order to make a profit. If you and your significant other submit a joint tax return and the two of you have an overall income of $200,000, you will just owe a 15% rate on any profits. This percentage is only associated with profits earned from cryptocurrency investments, not the overall yearly income.

If you hold your crypto for less than a year, you will pay a much higher tax amount than if you had sold it after having it for a year or longer – the rate will be lower.

Three Methods to Calculate Crypto Gains

Since the beginning of 2019, the regulations for computing the profits and losses from cryptocurrency investments have been quite simple. It is possible to use three distinct methods of accounting to compute profits, with examples for each given.

First-In-First-Out (FIFO)

The simplest way of calculating capital gains is using the First-In-First-Out approach. Using this technique, you get rid of your possessions in the same order in which they were acquired.

To illustrate, if you purchased a Bitcoin for $1000 on the first of January, you then purchased a second one two weeks later for $2000. Lastly, you bought an additional one after another couple of weeks at a cost of $1750. On the first of March, you made the decision to dispose of a Bitcoin when its value was $2500.

Using the FIFO approach, it would be necessary to dispose of the Bitcoin acquired on January 1st, since it was the first asset you bought.

If you sold your item for $2500, you would gain $1500 since you originally purchased it for $1000.

Last-In-First-Out (LIFO)

The Last-In-First-Out (LIFO) method is the opposite of FIFO. This technique involves unloading your assets in the opposite order that they were bought.

You would start by selling the second Bitcoin you bought on February 1st, since that was the most recently obtained asset.

The sale of an item for $2500 would result in $750 of capital gains, since that amount is $750 more than the original purchase price of $1750. Using the LIFO method would result in you saving $750 in terms of capital gains.

Highest-In-First-Out (HIFO)

The Highest-In-First-Out approach is the third approach used to determine crypto profits. Using this approach, the cryptography purchased at the biggest price would be disposed of first.

Under the FIFO approach from earlier (which had $1000, $2000, and $1750 buying prices according to the different situations), the HIFO technique would recommend that the second crypto acquired be sold first. The profit from the sale would be $500, since you would receive $2500 from the sale, but subtract the $2000 you originally paid for the item.

Which Method Is Best?

The HIFO approach demonstrated in the preceding situations offered the lowest taxable capital gains, but this would not always be the outcome. Typically, investors will still stick to the FIFO system since it is viewed as being the most secure of the three options.

It is suggested that the LIFO or HIFO strategies should only be implemented if an individual has kept an accurate account of all their cryptocurrency trades, including the date of purchase and the amount of the purchase.

When Are Cryptocurrencies Taxed Under Income Tax in the U.S.?

Now that we have explored the various rules and exemptions with respect to capital gains taxes, let’s investigate when virtual currency is taxed as income. A basic rule of thumb is to remember that any time you receive cryptocurrency, it must be reported for income tax purposes. The IRS lays down extensive guidance about scenarios when cryptocurrencies are seen as income instead of a capital gain, including:

1. When you get paid in crypto assets.
2. When you mine crypto as a hobby.
3. When you receive an airdrop.
4. When you receive new coins from a hard fork.
5. When you earn staking rewards.
6. When you earn crypto as referral bonuses.

As Decentralized Finance continues to develop and spread, there are now many more opportunities to gain cryptocurrency.

1. You can earn interest through yield farming on lending protocols like Compound and AAVE.
2. You can earn liquidity pool tokens, governance or reward tokens on Uniswap, for instance.
3. You can lend your crypto to, let’s say, NEXO to earn interest.
4. You can earn crypto dividends on platforms like CoinRabbit.

Cryptocurrencies earned on newly established engagement platforms could be thought of as a form of income. It is uncertain what taxes may apply to these kinds of transactions, but it is likely that any earnings made this way could be considered taxable income by the IRS. We suggest that you talk to a crypto tax specialist in order to get tailored advice regarding these investments. Examples of such transactions include:

1. Referral rewards as in Binance Referral.
2. Learn to earn campaigns, such as CoinMarketCap Learning Center and Coinbase Learning Center.
3. Watch to earn places like Odysee.
4. Browse to earn platforms such as Permission.io browser extension or the Brave browser.
5. Play to earn gaming apps like Axie In?nity.
6. Shop to earn browser extensions such as Lolli.
7. Share a public address and earn on platforms like Moon Faucet.

How Can You Benefit from Tax-Free Allowances in the U.S.?

Tax-free allowances can help reduce your crypto tax burden. Here’s how you can bene?t from them:

1. Gifting crypto assets under $16,000 in 2022 – Under the annual gift tax exclusion, citizens of the U.S. can gift up to $16,000 in crypto per person tax-free.
2. Capital gains tax-free allowance – If you earn below $41,675 in 2022 in total income, you don’t need to pay capital gains taxes on long-term gains.
3. Long-term capital gains tax rate – If you HODL (Hold On for Dear Life) your crypto asset for over a year, you pay a lower long-term capital gains tax rate between 0% to 20% based on your income.

How Do You Handle Capital Losses on Crypto Assets?

There are no taxes imposed on any losses incurred as a result of trading or using cryptocurrency. If you use cryptocurrency after its worth has grown, you will owe taxes on the proceeds as capital gains. By using your capital losses to offset your gains, you can lower your total tax liability. Capital losses that extend over a period of time can reduce capital gains that also last over a length of time, while shorter-term losses nullify shorter-term gains. The principle indicates that losses of the same kind can only be balanced out. But, there is an exception to this rule. Let’s examine a few situations in which you could possibly experience cryptocurrency losses.

1. Due to a crypto bear market, losses might be all you have. However, if you also invest in the stock market, you can use the capital losses from crypto to reduce your capital gains from the share market.
2. You only incurred losses on your crypto assets and don’t invest in any other markets, so you have no pro?ts. In this case, citizens of the U.S. can offset their short-term crypto losses against their income, up to $3,000 per year for citizens ?ling as single or married and ?ling jointly. You can also carry over these losses to the next tax years and offset them until all of them have been utilized.
3. You want to be strategic in offsetting your losses. You don’t necessarily have to offset your crypto loss the year you incur it. You can save it for a later tax year when you know you may realize some gains and may want to reduce your tax bill then.