Over the past decade, cryptocurrency has grown exponentially and has been used in different industries. It primarily functions as a medium of exchange, a unit of account, or a store of value. As a result, whether you receive, store, trade or send these digital assets, it’s important to understand the concept of cryptocurrency tax. Much the same as the Internal Revenue Service (IRS) regulations for asset classes like commodities, investing in cryptocurrencies generally incurs taxes.

Although the whole idea is still new, the IRS is working relentlessly to enforce crypto tax compliance. This guide will explain crypto taxes and highlight some taxable crypto events.

Cryptocurrency Tax

Ordinarily, cryptocurrencies are not taxable; that is, you’re not required to pay taxes for holding crypto assets. However, since these cryptocurrencies act as a medium of exchange, a store of value, a unit of account, and can be substituted for real money, the IRS treats crypto assets as property for tax purposes.

It also means that any profits generated from your cryptocurrency are taxable. Also, this concept doesn’t apply to trading cryptocurrency in a tax-free account like an individual retirement account (IRA). Establishing what falls under taxable crypto events can be a little bit daunting for some crypto users. Let’s examine more details about crypto taxable events.

What’s a taxable event?

Conventionally, a taxable event is any transaction carried out that may result in taxes liabilities to the government. Some popular examples include receiving payment of interest and selling stocks for profit. Ultimately, the evidence of any transaction is a taxable event.

The same principles apply to cryptocurrencies. Some taxable events include selling crypto for cash, converting one crypto to another, using crypto to purchase goods and much more. Listed here is a transaction that is taxable.

Cryptocurrency Taxable Events

Selling crypto for cash: Selling your crypto assets for fiat currencies will most likely incur tax. If you make a profit from the sale, you’ll owe taxes. In contrast, you can deduct that loss on your taxes if you sell at a loss.

Converting one crypto to another: Exchanging Ethereum for Bitcoin, for example, attracts crypto tax. Since it’s a sale, the IRS sees it as a taxable event.

Mining cryptocurrency: Since miners are rewarded for solving cryptographic hash functions to validate transactions, they are taxed. As a miner, it’s considered a taxable event if you profit from adding cryptocurrency transactions to a blockchain.

Spending crypto on goods: If you purchase goods such as fashion wear or foods, for example, with cryptocurrencies, you’ll likely incur taxes on the transaction.

How Do Cryptocurrency Taxes Work?

The IRS considers cryptocurrencies as assets. As such, they become taxable when they are used as payments or cash. Also, you owe taxes when you make profits on completed transactions.

For example, if you purchased 1 ETH at $1,000 and sold it at $4,000 a few weeks later, you’d owe taxes on the $3,000 profit according to the short-term capital gains tax rate. Gains realized on assets held for less than 12 months are taxable at your usual tax rate — between 0% and 37%, depending on your income.

Similarly, for long-term capital gains, depending on your overall taxable income, you would owe about 0%, 15%, or 20% for the specified tax year.

Wrapping Up

The concept of crypto tax is very much similar to the conventional tax process. Cryptocurrency transactions create taxable events when they are used to realize profits. It’s important for every crypto trader to understand how this concept works in order to stay prepared for any unforeseen rules and regulations.