The April 18 tax deadline is just weeks away, and for many Americans it will be the first time they answer questions about cryptocurrencies on their tax returns.
Crypto traders and NFT buyers and sellers will need to report their gains to the Internal Revenue Service so that they can be properly taxed. But it can be confusing to know if you owe taxes on your bitcoin, dogecoin, ether and other currencies, especially with the tricky cryptocurrency question that's included on every tax return.
For the second straight year, the first item taxpayers will encounter on their 1040 forms after filling out their contact information is a question asking if "at any time during 2021, did [they] receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency."
"If you just bought it and didn't sell anything, you can actually answer 'no' to that question because you do not have any taxable gains or losses to report," he says.
But if you bought and sold cryptocurrency, or otherwise spent your crypto or exchanged it for other digital tokens, you must respond "yes" to the question.
That's because under U.S. tax law, bitcoin and other cryptocurrencies are classified as property and subject to capital gains taxes, meaning that you owe taxes on the increase in value of your property from when you first bought it. But you only owe taxes when those gains are realized.
"Any time you sell a cryptocurrency or trade it for another form of property, or if you're using it for a means of payment, you are incurring a taxable event," Woodward says.
The amount you will owe depends on how long you held your cryptocurrency, and whether you sold or exchanged it for a profit or a loss. If you owned your crypto for under a year, the taxes you pay on any gains will be the same as your normal income tax rate.
If you owned your crypto for more than a year, you will pay a long-term capital gains tax rate, which is determined by your income. For single filers, the capital gains tax rate is 0% if you earn up to $40,400 per year, 15% if you earn up to $445,850 and 20% if you make more than that. This IRS worksheet can help you do the math.
Investors who sold or exchanged their crypto at a loss — for example, buying bitcoin at $60,000 and selling it at $30,000 — can use their losses to lower their taxable income by a maximum of $3,000. Any additional losses can be carried over to future years.
Woodward encourages anyone who has incurred losses to be proactive about reporting them to the IRS, no matter how small. Failing to do so, he warns, could result in an IRS audit.
"They have a lot of infrastructure and teams in place to go after known cryptocurrency users that don't report," he says. "There might be some costs associated with navigating an audit that you would otherwise not want to go through if you had just reported your losses."
Whatever you do, make sure you don't fail to report any crypto transactions to the IRS, Woodward says. Tax returns are signed under the penalty of perjury, and it is possible that you can be caught lying to the IRS.
"I think one of the misconceptions of crypto is that it's anonymous and there's not a record of who's using it and what's happening," he says. "You should report under the assumption that the IRS knows about it anyway."
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