When tax season comes around, you may be looking at a harsh reality if you purchased cryptocurrency last year.
Cryptocurrencies such as Bitcoin, Ethereum, and others are subject to taxes. For tax reasons, the IRS considers cryptocurrency holdings to be “property,” which means your virtual currency is taxed similarly to any other asset you own, such as stocks or gold.
The deadline to file your 2021 taxes or request an extension was April 18. You have until October 17, 2022, to file if you sought an extension.
For the first time, many new investors invested in cryptocurrency in 2021. Over half of existing Bitcoin investors started investing in the past year, according to a recent study. There have been many highs and lows in the crypto market throughout the year, resulting in huge gains and losses for many investors.
2021 was a great year for cryptocurrency, and many newcomers to the space in the last 12 to 24 months may now be paying crypto taxes for the first time.
People who buy and trade cryptocurrency on internet exchanges have no problems accounting for cryptocurrency on their tax returns. Nonetheless, as with most things related to digital currency, things can get more complex as you get more involved.
Here’s everything you need to know about which activities you might have to record to the IRS, as well as how to start thinking about your taxes.
When Do You Need To Report Crypto Trades On Your Tax Return?
- Buying Bitcoin using Dollars
When you buy virtual currency with US dollars and keep it in an exchange or transfer it to your personal wallet, you may not have to pay taxes on it when the year ends.
The IRS doesn’t require you to report a cryptocurrency transaction if your only crypto-related action this year was purchasing a virtual currency with US dollars.
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- Cryptocurrency Trading
Utilizing crypto as a trading medium will result in things becoming taxed. It also includes exchanging one cryptocurrency for another – such as buying Ethereum with Bitcoin – and paying for products and services using bitcoin.
The term “taxable transaction” refers to a transaction in which an investment is sold or exchanged for another.”
If you trade frequently, you must exercise caution. It’s a taxable event every time you trade in and out of different types of cryptocurrency.”
- NFT Trading or Minting
A non-fungible token, or NFT, is a blockchain-based token that shows you are the only owner of a one-of-a-kind digital item, such as a digital sports collectible or an animated flying cat with a Pop-Tart body. Digital marketplaces allow you to buy and sell NFTs.
If you are creating or minting NFTs, it is crucial to understand what events are taxable as well as how they are taxed. For example, petrol fees are taxable when used to mint NFTs. Imagine investing 0.1 Ethereum to build NFTs for fun. When you minted the NFT, this Ethereum was worth $300, so you made a $200 profit when you bought it for $100. You’d be subject to either a long-term or short-term capital gains tax rate depending on how long you possessed Ethereum before using it to mint the NFT. The $100 would be regarded as regular if you were a professional creator who routinely minted NFTs for your business.
Therefore, this is when you need to pay taxes on cryptocurrencies. Now, let’s move on to see how to report cryptocurrency to the IRS in 2022.
How To Report Cryptocurrency to IRS?
Cryptocurrency gains and losses are reported in the same way that gains and losses from stock or other types of property are reported.
To file your cryptocurrency taxes, you should follow these five steps:
- Calculate your cryptocurrency profit and loss
You will experience capital gains or losses each time you sell your cryptocurrency. The following are examples of disposal events:
- Buying fiat currency with your cryptocurrency
- Your cryptocurrency can be exchanged for another cryptocurrency.
- Using cryptocurrencies to purchase products and services
To figure out how much you made or lost on each transaction, keep note of how the price of each of your assets has changed since you first got them.
Capital Gain / Loss = Value at Time of Scale – Cost Basis
- Fill out IRS Form 8949
The IRS Form 8949 is used to report capital asset sales and disposals. Stocks, bonds, and, yes, cryptocurrencies are instances of capital assets.
You’ll need the following information on each individual transaction in addition to reporting your capital gains and losses on Form 8949:
- A summary of the property you sold
- The date you first purchased the property
- The property was sold or disposed of on which date
- The sale’s proceeds (fair market value)
- The cost basis on which you purchased the property
- Gain or loss
- Include totals from 8949 on Schedule D
After you’ve completed your 8949, add up your total net gain or loss on Schedule D.
You can record your total capital gains and losses from all sources on Schedule D. Other line items reported on Schedule D include Schedule K-1s from enterprises, estates, and trusts, in addition to your short- and long-term gains from 8949 and your crypto activities.
- Include any cryptocurrency earnings
Cryptocurrency can be generated by mining, staking, referral bonuses, or labor in some cases. When you earn cryptocurrency through these methods, you are recognizing income and will be liable to income tax.
- Finish the remainder of your tax return
You should be finished reporting all crypto-related transactions on your tax return now that you’ve completed 8949 and included your crypto revenue. You’ll be able to submit your tax return to the IRS once you’ve completed the remainder of your forms.
Therefore, these are the five quick and easy steps to report cryptocurrency to the IRS. Now, let’s see how you can track your activities.
One of the most important things to remember once you begin dealing in cryptocurrencies is that it is your responsibility to maintain track of any potentially taxable activities, as well as the fair market value of your crypto at all times.
The IRS only gives general guidelines for the data you’ll need to save for tax reporting, stating that it should be adequate “to substantiate the positions taken on tax returns.” The agency provides examples such as records of any time you receive, sell, or exchange virtual currency, as well as the fair market value of your virtual currency.
According to predictions, this will not be the case for the 2023 tax year. Under a section of the $1.2 trillion bipartisan infrastructure package signed into law by President Biden last November, brokers, or bitcoin exchanges, are required to send a 1099-B. In other words, crypto exchanges will be required to instantly disclose cryptocurrency transactions to the IRS.
If you retain your virtual currency in your account on the exchange where you got it, it’s usually simple to track or create information about your transactions. You’ll need to be extra thorough in your tracking if you move your cryptocurrency between private wallets or have it in many locations.
Need Assistance With Cryptocurrency Reporting
The Freecashflow.io team has extensive experience aiding internet business owners with tax and accounting concerns. Some of our peers have worked for multibillion-dollar corporations including Warner Brothers, EY, and Paramount Pictures. You may rely on us for cryptocurrency tax and accounting help. Please do not hesitate to contact us!