Bitcoin Tax: Taxes on Crypto Explained

In 2014, the Internal Revenue Service (IRS) sent the cryptocurrency community into a frenzy when it announced that it would treat virtual currency as property for federal tax purposes. The classification of cryptocurrency as property has many enthusiasts wondering how they’re supposed to accurately report their taxes, especially those that frequently trade one crypto for another. Below, we lay out what you need to know about paying taxes on your bitcoin and other cryptocurrencies. 

Do You Have to Pay Taxes on Bitcoin and Other Crypto?

If you dabble in the cryptocurrency space, then it’s likely you’ll have to pay taxes on your bitcoin and/or other crypto. Since the IRS treats cryptocurrency as property, anytime you sell, receive, stake, trade, mine, or a cryptocurrency hard forks, it creates a taxable event. The size of the transaction is irrelevant in the eyes of the IRS since they expect you to report a gain or a loss on the aforementioned transactions.

Below, we cover common events crypto enthusiasts encounter and whether they constitute taxable events. 

Buying Crypto

The good news for holders (or hodlers) is that if all you have ever done is bought and held crypto, then you don’t have to report your crypto transactions on your taxes. That’s because holders of crypto have unrealized gains and/or losses. However, be aware that if the crypto you bought and held has ever hard forked, then you would have to report any income you might have received from the event.

Taxable event: Not in most instances. 

Pro Tip: Hard Forks Explained
A hard fork is a change to the underlying technology of a cryptocurrency network that is not compatible with the current system of rules governing the network, resulting in two versions of the software. The two separate crypto networks created as a result of a hard fork often result in two separate cryptocurrencies.   

Selling Crypto

If you have sold crypto in the latest tax year, then you will have to report the transaction(s) on your tax filing. The profit you generate will be taxed as a capital gain. Capital gains on crypto are discussed further below, but in summary, you’ll be taxed at a short or long-term capital gains tax rate depending on how long you held the crypto before selling.

Taxable event: Yes

Trading One Crypto for Another

Crypto-to-crypto trades are essentially treated as two separate transactions even if they’re not. When trading Ethereum for Bitcoin, for example, there would be two transactions in the eyes of the IRS: the sale of Ethereum and the purchase of Bitcoin. 

  • Sale of Ethereum: You would be subject to short or long term capital gains tax on any gains on the sale of Ethereum, depending on how long you held the asset prior to trading it for Bitcoin.
  • Purchase of Bitcoin: As we’ve covered above, buying crypto (Bitcoin in this instance) wouldn’t create a taxable event.

It’s worth noting that when you trade Ethereum for Bitcoin you would be establishing a new cost basis for your crypto. The implication being that when you eventually go on to sell your Bitcoin, you would pay taxes on the gains relative to how much you paid for the Bitcoin (not Ethereum) plus any applicable exchange fees.  

Taxable event: Yes

Example

Trading Crypto for Crypto

At the beginning of the year you buy $5,000 worth of Bitcoin. As the year goes on, the value of your Bitcoin rises to $10,000. You decide you want to trade it for Ethereum, so you execute a trade of $10,000 Bitcoin for $10,000 Ethereum. In this scenario, you would only have to report and pay taxes on the sale of Bitcoin for $10,000, representing a $5,000 gain. The purchase of Ethereum would be seen as the purchase of a crypto and not subject to tax reporting.     

Making a Purchase with Crypto

Since crypto is treated like property, making a purchase with crypto means you’re essentially trading property for a product or a service. As a result of this, you’re expected to pay taxes on any gains you might have on the date the transaction takes place – even if you’re not converting to fiat to make the purchase. This might make Bitcoin holders take pause before purchasing a Tesla with their holdings.   

Taxable event: Yes.

Mining Crypto

If you mine crypto, be prepared to pay income tax on the fair market value of any crypto you mine as of the date you receive it. You’ll also be subject to a capital gains tax when you eventually sell the coins you’ve mined. 

Taxable event: Yes.

Receiving an Airdrop

Any coin you receive in an airdrop is taxed as income at the fair market value of the asset on the day of receipt. 

Taxable event: Yes.

Pro Tip: Airdrops Explained
An airdrop is when a new cryptocurrency is automatically deposited into users’ wallets for free. Typically, the goal of an airdrop is to generate buzz around the deposited crypto and establish a large user network.

Forks

Soft forks that don’t result in the creation of a new coin are not taxable events. On the flip side, if you receive new coins after a hard fork, the fair market value on the day of receipt of the coins will be treated as ordinary income. This is an area where investors need to be careful since a hard fork could occur on a coin they own, triggering a taxable event without the holder being aware.

Taxable event: Not for soft forks, but yes for hard forks resulting in new coins. 

Pro Tip: Soft Forks Explained
A soft fork is a change to the underlying technology of a cryptocurrency network that is backwards compatible. It may help to think of a soft fork as a software update for the network, where the resulting update doesn’t lock out users who don’t update the software. This is in stark contrast to a hard fork, where software updates are mandatory and lack of compliance leads to a network splitting into two separate networks. 

Getting Paid in Crypto

From a tax perspective, getting paid in crypto is the same as getting paid in fiat. Any coins you receive will be taxable as income based on the fair market value of the coins on the day you receive them.

Taxable event: Yes.

Transferring Crypto Between Your Wallets or Exchanges

Transferring crypto from one wallet to another is not taxable. Similarly, transferring crypto from an exchange, like Coinbase or Binance, to a personal wallet is not taxable. 

Taxable event: No

Pro Tip: Seek Professional Advice
The IRS’ guidance on cryptocurrency and taxation is constantly evolving. In fact, just this past year the IRS updated form 1040 to include a prominent question about receiving, selling, sending, exchanging or acquiring interest in virtual currency. Due to ongoing changes in guidance, if you need information on whether a specific crypto activity is taxable (e.g. staking and lending), we recommend reaching out to a professional. Taxes are a complicated matter and oftentimes with crypto unique considerations make general information suboptimal. 

How is Bitcoin and Other Crypto Taxed?

The tax you’re liable to report and pay on bitcoin and other cryptocurrencies depends on how long you’ve held the assets before selling or otherwise disposing of them and your ordinary tax rate. Keep in mind that certain crypto activities, such as staking, have yet to receive official IRS guidance.

If you’ve held coins for 365 days or less (Short-Term Capital Gains)

Any coins you’ve held for a period of 365 days or less are subject to a short-term capital gains tax. Short-term capital gains are taxed as ordinary income and is the most unfavorable tax treatment. Below, we lay out the short term capital gains tax brackets per the latest IRS release for the 2020 tax year. 

Tax RateSingleMarried Filing JointlyHead of Household
10%$0 – $9,875$0 – $19,750$0 – $14,100
12%$9,876 – $40,125$19,751 – $80,250$14,101 – $53,700
22%$40,126 – $85,525$80,251 – $171,050$53,701 – $85,500
24%$85,526 – $163,300$171,051 – $326,600$85,501 – $163,300
32%$163,301 – $207,350$326,601 – $414,700$163,301 – $207,350
35%$207,351 – $518,400$414,701 – $622,050$207,351 – $518,400
37%$518,401+$622,051+$518,401+

If you’ve held more than 365 days (Long-Term Capital Gains)

Any coins you’ve held for 366 days or longer are subject to long term capital gains tax. Depending on your income and filing status, the tax rate ranges from 0% to 20%. Below, we lay out the long term capital gains tax brackets for the 2020 tax year.

Tax RateSingleMarried Filing JointlyHead of Household
0%$0 – $40,000$0 – $80,000$0 – $53,600
15%$40,001 – $441,450$80,001 – $496,600$53,601 – $469,050
20%$441,451+$496,601+$469,051+
Example

Short Term Versus Long Term Capital Gains on Crypto

Scenario 1 (Short Term Capital Gains): You’re filing your taxes as single and earning $75,000 per year. You purchase $5,000 worth of Bitcoin in January and proceed to sell it in March of the same year for $7,000. Since you held your Bitcoin for less than one year, your gain of $2,000 is taxed at the short-term capital gains tax rate for your tax bracket and filing status of 22%.
22% of $2,000 is $440, meaning you would have to pay $440 in federal taxes for your crypto activity. Additionally, you might end up owing state taxes on top of the $440, depending on the state you live in during the tax reporting year. 

Scenario 2 (Long Term Capital Gains): You’re filing your taxes as single and earning $75,000 per year. You purchase $5,000 worth of Bitcoin in January and proceed to sell it in March of the following year for $7,000. Since you held your Bitcoin for more than one year, your gain of $2,000 is taxed at the long term capital gains tax rate for your tax bracket and filing status of 15%.

15% of $2,000 is $300, meaning you would have to pay $300 in federal taxes for your crypto activity. Additionally, you might end up owing state taxes on top of the $300, depending on the state you live in during the tax reporting year. 

Bitcoin and Other Crypto Tax Reporting

The information above might be helpful for casual crypto fans with one or two transactions under their belt, but more active market participants, like crypto traders, will need to track their tax lots to accurately report their taxes. A tax lot is simply a record of details made when acquiring an asset. To accurately calculate your crypto taxes you’ll need the following information for every single one of your trades:

  • The dollar amount you paid for the asset
  • The dollar amount at which you sold the asset
  • The amount of time during which you held the asset

The dollar amount you paid for your asset establishes your cost basis, while the dollar amount for which you sell your asset establishes your proceeds. Netting the two gets you your gain (or loss) on the trade. From there, the amount of time during which you held each asset and your filing status determines your tax rate. Your tax rate is multiplied by your gain to get down to your tax bill. 

It’s easy to see how quickly this can start to become a complicated and unmanageable process. Consider someone who trades multiple times per day in several currencies and holds assets for varying periods. It would create a nightmare scenario and make it practically necessary to use crypto tax software, which we discuss further below.  

Crypto Accounting Methods: FIFO vs Specific ID

According to the IRS, if you own multiple units of cryptocurrency, you may identify which unit or units are involved in a specific transaction. The implication of the guidance is that investors can use different accounting methods for tax reporting purposes. 

The best way to explain different accounting methods is with an overarching example. Let’s assume you execute the following trades, where you’re purchasing and selling Bitcoin. For simplicity’s sake, each transaction is either purchasing or selling one entire Bitcoin.

#Buy or SellMonth/
Year
PriceFeesCost
Basis
Spec
ID
1Buy3/2021$50,000$100$50,100X909
2Buy4/2021$55,000$100$55,100X876
3Sell6/2021$65,000X876
4Sell7/2021$75,000X909

Below, we lay out two different accounting methods for crypto taxes along with short explanations of how the methods function.

  • First in First Out (FIFO): Under FIFO, you attribute a sale to the coin you bought first.
  • Example: When transaction 3 takes place, you’re selling the bitcoin you purchased in transaction 1, making the Bitcoin in transaction “first in, first out”. Subtracting the cost basis of $50,100 from the sale price of $65,000 returns $14,900, which would be your realized gain and subject to taxation. When transaction 4 takes place, you would be selling the bitcoin you purchased in transaction 2 and so on.
  • Specific Identification (Spec ID): Under Spec ID, you’re uniquely identifying the units you’re selling whenever you execute a trade. Essentially, through the method you’re hand picking the specific crypto units you’d like to dispose of and calculating gains or losses based on the details surrounding the purchase of the specific units.   
  • Example: We’ve included a Spec ID column in the table above to help you visualize what this might look like. In our table, the Spec ID method might not look so impressive or complex, but consider a trader with thousands of transactions. 

The downside of Spec ID is that you must maintain meticulous records about your transactions, including, but not limited to purchase dates, times, and the fair market value of each unit at the time of purchase or disposition. Generally, we don’t believe this is a method most investors will be able to reap the benefits of without a little help from crypto tax software, which is discussed further below.  

Forms Self-Filers Might Need

If you’re planning to prepare your own taxes, you’ll likely need to fill out several tax forms, which we lay out below:

  • Form 8949: You can use Form 8949 to report any capital gains or losses stemming from your crypto activity.
  • Form 1040 (Schedule D – Capital Gains and Losses): You use this form to summarize the activity listed in your Form 8949.
  • Form 1099-MISC: You use this form to report miscellaneous income from activities such as staking, or earnings programs made available through exchanges like Coinbase. 

Crypto Tax Software

Given that reporting crypto taxes is a convoluted mess of a process, recently, several companies have joined the battle to become the TurboTax of the crypto space. If you keep most of your crypto activity limited to one or even just a couple of exchanges, these crypto tax software companies can examine your trade history and spit out the required IRS forms.

The services range in terms of cost and features, but can be well worth it for people with a complex trading history or someone who just wants a hands off approach to crypto taxes. Below, we list a few of the most popular crypto tax software platforms for your convenience:

  • Accointing
  • CryptoTrader.Tax
  • CoinTracker
  • Koinly
  • Taxbit

Even if you’re using crypto tax software to produce your tax forms, it’s always a wise idea to give the information a close examination to ensure it ties out to your actual transactions. 

Amending Tax Returns for Crypto

If you’ve failed to report previous year’s crypto activity, you’re in luck since the IRS allows taxpayers to amend federal returns for up to three years from the date the original return was filed. However, keep in mind that if you end up owing taxes, which will likely be the case since the crypto market has boomed over the past several years, you might face fees in the form of penalties and interest. It’s a low cost for peace of mind.

You can file an amended return by filing Form 1040X. The form cannot be e-filed and must be sent by mail, preferably by certified mail, so you can ensure receipt and have a record of a delivery date. Amending your federal returns likely means you’ll have to amend state returns as well. You should be prepared to face penalties and interest at the state level.    

Does Coinbase Report to the IRS?

In 2016, the IRS demanded user data on around 500,000 Coinbase customers, including customer names, addresses, account statements and transaction logs. Coinbase initially fought the demand, but eventually turned over customer data on around 13,000 customers. The specific users whose account information was turned over completed at least one transaction in the amount of $20,000 or more between 2013 and 2015.

More recently as of 2020, Coinbase has opted to send users 1099-MISC forms to customers who are Coinbase members, U.S. based, and have earned $600 or more in rewards or fees on the platform. A 1099-MISC form simply details the income you’ve earned on the Coinbase platform. If you receive a 1099 form from Coinbase, it might be the case that the IRS received one as well. 

Closing Thoughts on Bitcoin and Crypto Taxes

As mentioned previously, the crypto tax space is constantly evolving as new products and services are created. As an investor, you’ll want to stay on top of the latest guidance provided directly from the IRS to ensure you’re staying compliant with reporting crypto taxes.

If you are in any doubt as to how to report your cryptocurrency taxes, we urge you to take the proper precaution and reach out to a professional. Otherwise, you risk stiff penalties, fees, and possible criminal prosecution.  

Disclaimer: The author of this post does not provide tax or legal advice. The material above has been written for general informational purposes. It should not be considered a recommendation or personal advice. Please consult with a professional regarding your specific situation.