Cryptocurrency and NFTs — How Are They Taxed?
Bitcoin, Ethereum, Tether, NFTs — regardless of your preferred blockchain investment, it’s undeniable that their popularity as an investment vehicle has exploded over the past decade; more than one in six Americans have traded, used, or invested in crypto. And while crypto’s high volatility compared to traditional securities attracts financial risk-takers, it has also attracted the attention of the IRS.
At its inception, cryptocurrency sought to provide added privacy to its users via a more opaque alternative to fiat currency. One unfortunate side effect of crypto’s lack of oversight is that it provides criminals an additional avenue to launder money. After pressure from governments and tax authorities, cryptocurrency exchanges such as Coinbase and Binance implemented transparency measures, including a requirement to report any and all crypto-related “taxable events” incurred by the user. These taxable events include:
- Selling or exchanging crypto for fiat currency
- Selling or exchanging one type of cryptocurrency for another (i.e., exchanging Bitcoin for Ethereum)
- Spending crypto on goods or services.
How Are Cryptocurrency Transactions Taxed?
The IRS assesses taxes on crypto transactions based on the fair market value (in USD, of course), of the relevant cryptocurrency at the time of the transaction. If the cryptocurrency’s value at the time of the transaction exceeds its value when initially purchased by the taxpayer, the taxpayer must report the transaction as a capital gain.
This can get especially confusing when considering that many cryptocurrency transactions entail fractions of single coins. For example, if you were to buy a pizza with Bitcoin, the pizza would cost only an infinitesimal fraction of a single Bitcoin. Still, you must pay capital gains tax on that fraction if you bought the pizza when Bitcoin is worth more than it was when you acquired the crypto.
How to Avoid Paying Taxes on Crypto
To avoid paying taxes on cryptocurrency, you must avoid incurring a taxable event. In the plainest possible terms, don’t sell or exchange your crypto unless you have reached your equity goals.
The IRS taxes gains made through mining cryptocurrency as regular income, however.
Capital Gains Tax Basics
There are two types of capital gains tax: short-term and long-term. Luckily, both types are relatively straightforward — at least as far as taxes are concerned.
Short-Term Capital Gains Tax
Short-term capital gains tax applies when an investor realizes an investment held for under one year total — hence, “short-term”. There are no special rules for short-term capital gains; they are taxed as ordinary income.
Long-Term Capital Gains Tax
The 2018 Tax Cuts and Jobs Act lowered the long-term capital gains tax rate. And if you are a single filer, you don’t have to pay any tax on long-term capital gains of under $40,000 ($80,000 if married and filing jointly.
However, unless you live in Alaska, Colorado, Florida, Nevada, New Hampshire, New Mexico, South Dakota, Tennessee, Texas, Wyoming, or Washington, you also have to pay capital gains tax at the state level. The amount you have to pay varies from state to state — be sure to confirm what you’ll owe on your state’s Department of Treasury website.
