| 2024 Capital Gains Tax Rates | |||
|---|---|---|---|
| Filing Status | 0% Tax Rate | 15% Tax Rate | 20% Tax Rate |
| Single | Up to $47,025 | $47,025 to $518,900 | Greater than $518,900 |
| Head of Household | Up to $63,000 | $63,000 to $551,350 | Greater than $551,350 |
| Married Filing Jointly | Up to $94,050 | $94,050 to $583,750 | Greater than $583,750 |
| Married Filing Separately | Up to $47,025 | $47,025 to $291,850 | Greater than $291,850 |
Bitcoin Taxable Transactions
The IRS has provided specific guidance on transactions involving digital assets that are to be included in a tax return. Note that the extent of these transactions may make for difficulty when tracking all transactions; cryptocurrency investors and users are advised to seek tax advisor guidance to ensure all of the following transactions are adequately being reported:
- Sale of a digital asset for fiat
- Exchange of a digital asset for property, goods, or services
- Exchange or trade of one digital asset for another digital asset
- Receipt of a digital asset as payment for goods or services
- Receipt of a new digital asset as a result of a hard fork
- Receipt of a new digital asset as a result of mining or staking activities
- Receipt of a digital asset as a result of an airdrop
- Any other disposition of a financial interest in a digital asset
- Receipt or transfer of a digital asset for free (without providing any consideration) that does not qualify as a bona fide gift
- Transferring a digital asset as a bona fide gift if the donor exceeds the annual gift exclusion amount
Bitcoin Tax Basis
In its broadest sense, the tax basis of Bitcoin used to determine your gain or loss is the cost for which the digital currency was obtained or its market price at the time it was acquired. For example, assume you acquired 100,000 Satoshi when Bitcoin traded at $20,000/coin. The cost basis of the acquisition would be $20.
In the example above, should the Bitcoin be sold for $25 more than one year later, a $5 taxable capital gain would occur. If the Bitcoin were sold for $14, a $6 loss would occur. If you sold it for $25 six months later, $5 in taxable income would need to be reported.
The tax basis of Bitcoin becomes more complicated as less straightforward transactions occur. For example, an investor may receive airdropped tokens or tokens in exchange for a service at no cost. In most of these situations, the airdropped digital currencies would have a basis equal to the fair market value at the time of acquisition. This tax treatment is similar to that of stocks and bonds.
Tax Implications of Bitcoin Mining
Cryptocurrency mining is also considered a taxable event. The fair market value or cost basis of the coin is its price at the time at which it was rewarded to you. The nature of those deductions differs based on whether you mined the cryptocurrencies for personal or business gain.
If you run a mining business, then you can make the deductions to cut down your tax bill. But you cannot make these deductions if you mined the cryptocurrencies for personal benefit.
Tax Implications of Swaps
Some have argued that conversion of one cryptocurrency to another, say from Bitcoin to Ether, should be classified as a like-kind transfer under Section 1031 of the Internal Revenue Code. The IRS allows you to defer income tax on exchanges of like-kind property when they are exchanged for productive use in a business or investment.
However, in a Memorandum from the Office of Chief Counsel released on June 18, 2021, the IRS ruled that such exchanges do not qualify as a like-kind exchange under Section 1031. What's more, the Tax Cuts and Jobs Act (TCJA) of 2017 put an end to that practice by clarifying that like-kind transfers are restricted to property transactions.
If you receive cryptocurrency in a transaction performed via an exchange, the value of the digital currency received is recorded by the exchange at the time of the transaction. If the transaction is performed outside of the exchange (P2P), the basis of the cryptocurrency is the fair market value at the time.
Tax Implications of Hard Forks
Hard forks of a cryptocurrency occur when a blockchain split occurs, meaning there is a change in protocols. This creates a taxable event if new cryptocurrencies are acquired because of it. For instance, imagine a blockchain was split, and a new coin, with differences in mining and use cases, was created. Holders of the original cryptocurrency are given new coins. This practice is called an airdrop and is also used as a marketing tactic by developers of new coins to induce demand and usage.
In a 2019 ruling, the IRS clarified that hard forks do not result in gross income, if the wallet holder does not receive units of cryptocurrency. Airdrops, on the other hand, qualify as gross income after the holder receives units of a new cryptocurrency either after a hard fork or by marketers of a coin. In the latter case, the quantity and time at which a crypto wallet holder receives the new coins determines the tax amount. Airdrops are taxed as ordinary income.
A critical note here is the coins' value when you receive them. A new coin might be forked from Bitcoin, with the developers stating it has a certain value. However, just because the creators state this doesn't mean the airdropped crypto was worth it—it is worth whatever its fair market value was on that day because it is no longer Bitcoin, and cryptocurrency creators of non-security tokens do not dictate market value. A security token would likely be issued with a value because you're buying an asset being issued like a stock.
Tax Implications of Gifting Bitcoin
Cryptocurrency donations are treated similarly to cash donations. They are tax-deductible, though donors face limits on how much they can deduct based on their adjusted gross income. An appraiser will assign a fair market value for the coin based on its market price at the time of donation. The donor is not required to pay any taxes on the price gain.
The IRS established an annual gift tax exclusion. In 2023, taxpayers were allowed an annual exclusion per donee for a gift amount of up to $17,000. This limit was increased to $18,000 in 2024.
Special Considerations
The volatility of Bitcoin's price makes it difficult to determine the fair value of the cryptocurrency on purchase and sale transactions. You should always track transactions as they occur, as retrospectively needing to obtain financial information (even on distributed ledgers) may prove to be difficult.
How Can I Avoid Paying Taxes on Bitcoin?
The only way to avoid paying Bitcoin taxes is to not sell or use any during the tax year. Receiving Bitcoin as an airdrop or in exchange for service has tax implications, but most taxable events are triggered by the sale or exchange of the cryptocurrency.
Does the IRS Know I Own Bitcoin?
All centralized exchanges have "Know Your Client" reporting obligations in which investors must upload their photo identification and some personal information. If your trading platform provides you with a Form 1099-B or Form 1099-K, the IRS is informed that you have transacted with the trading platform.
What Happens If You Don't Report Taxes on Bitcoin to the IRS?
Tax evasion occurs when taxpayers knowingly fail to report and pay taxes on any source of income, whether related to cryptocurrency, wages, salaries, stocks, real estate, or other investments. If the IRS has reason to believe you have engaged in tax fraud, it may audit you. Be mindful that trading platforms may issue tax statements notifying the IRS that you have engaged in cryptocurrency transactions.
The Bottom Line
Cryptocurrency is an exciting, volatile, risky, and emerging market. Those investing, trading, or using Bitcoin should take care to learn the tax implications of their digital currency moves.
Most transactions trigger taxable events, and your Bitcoin's tax basis is usually the cost basis or fair market value at acquisition. Knowingly avoiding reporting income or gains on cryptocurrency is considered tax fraud.
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