Is My Cryptocurrency Wallet Taxable?
The Basics of Cryptocurrency Reporting
It was a big year for cryptocurrency in 2021, which meant many investors were buying in for the first time. According to a recent study, more than half of current Bitcoin investors began investing in the past 12 months. Did you invest in cryptocurrency this past year? Or do you plan to in the coming year?
Throughout cryptocurrency’s relatively new lifespan, the IRS has considered any cryptocurrency holdings to be property for tax purposes. This means, upon selling or trading any virtual currency in your wallet, you will be taxed in the same way as other assets such as stocks, bonds or real estate investments. Activity within the cryptocurrency space will add complexity to your tax return. Below are a couple different scenarios which may apply to you:
- Purchasing with U.S. Dollars – If you purchase virtual currency with U.S. dollars and either hold it within the exchange where you made the original purchase or transfer it to your personal cryptocurrency wallet, you will not owe taxes on it at tax filing time. For example, if purchasing was your only cryptocurrency-related activity in 2021, you didn’t have to report those purchases to the IRS during your recent tax return filing. Keep in mind, though, the rules surrounding cryptocurrency are rapidly changing.
- Trading Cryptocurrency – Taxable events begin to happen when you use cryptocurrency in trade. This includes selling any virtual currency for U.S. dollars, exchanging one type of cryptocurrency for another, or paying for goods and services with cryptocurrency. The IRS is taking a harder look at trades made in the crypto space, so be sure to talk to an advisor to ensure you’re reporting your transactions correctly.
When Will I Owe Taxes?
Since cryptocurrency is considered property, the taxable value will be based on capital gains or losses – how much value the currency you were holding gained or lost in each period. A capital gain is the difference between the value of the virtual currency when earned or purchased and the amount you receive when selling or trading. The length of time you hold onto cryptocurrency also plays a part in taxation.
- If you held onto a virtual currency for more than one year, this generally qualifies it as long-term capital gains.
- However, if you bought and sold the virtual currency in one year or less, it’s a short-term gain. Short-term capital gains are generally taxed as ordinary income.
These specifications affect which tax rate is applied, which affects your overall taxation.
The world of cryptocurrency trading is wild and woolly, with extreme price volatility. Only investors with nerves of steel and an understanding of the risks involved should venture into this market. As such, timing is very important, as is preserving enough capital to cover tax liability when downturns occur after crossing tax years. Having a boom year for which you owe significant taxes, followed quickly by a drop in crypto values, may leave you cash poor and unable to pay the tax bill. It has happened more than once.
Cryptocurrency is both exciting and complicated. The rules continue to shift and evolve. Make sure to consult with your Adams Brown tax advisor if you have any questions regarding your cryptocurrency wallet.