US Crypto Tax Rules: When Do You Have To Pay Tax On Cryptocurrency?

Let’s say you buy 1 BTC for $50,000, its market value increases to $75,000, and you sell it. That’s $25,000 in capital gains you’ll need to report in your taxes. That one’s easy.

But when you trade one crypto for another, non-IRS folks like us might see that as one transaction. Let’s say you traded Bitcoin for Ethereum. Simple, right? Not so much.

Uncle Sam sees it differently. Everything must be valued in USD. Your simple transaction is really three transactions with a whole bunch of numbers to track.

• You bought Bitcoin
• You sold Bitcoin
• You bought Ethereum

Here are the numbers you’ll need to know:

• How much did you pay for Bitcoin in USD?That’s your cost basis.
• How much was Bitcoin worth at the time of the trade? That’s your selling price.
• How much were the fees? Trading fees get added to your cost basis.
• How much money did you make or lose on Bitcoin? That’s your capital gain or loss. Subtract your cost from the selling price.
• How long did you hold the Bitcoin? If it was less than a year and you had a gain, you’ll pay the short-term capital gains tax rates (taxed as regular income).
• Lastly, what was the cost of Ethereum in USD? That’s your cost basis for when you eventually spend or sell your Ethereum. Uncle Sam sees this as a new purchase rather than an exchange.

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For example, if you buy an NFT for $500 and trade for another NFT worth $700, you’ve earned a $200 (taxable) capital gain. Remember, the IRS sees this as three transactions.

• Buy NFT A
• Sell NFT A
• Buy NFT B

But If you mint NFTs, the profit from selling your NFTs would be considered ordinary income—unless you’re just a hobbyist. As a hobbyist, the minting cost becomes your cost basis, and a sale above your cost basis is a capital gain.

NFTs can also provide passive income, such as royalties or rental fees. Passive income is still just income in the eyes of the IRS. Income is taxable.

Abbatiello tells us that he always tries to relate the transaction to a normal fiat transaction. If you’re renting out an NFT for a fee, then that should be treated similarly to renting any other type of property.

In 2020, Uniswap airdropped 400+ UNI tokens to over 250,000 wallet addresses that had interacted with the popular decentralized exchange.

Bitcoin Cash was a hard fork of Bitcoin—and Bitcoin holders suddenly had both coins.

How does the IRS see these transactions? Well, the crypto fairy left crypto under your pillow, which makes the new coins or tokens taxable income. The USD value of the coins or tokens at the time of receipt becomes your cost basis used to calculate gains or losses if you sell or spend that crypto later.

Abbatiello tells us that there is a big argument that you shouldn't pay taxes on cryptocurrency until it’s sold, but he suggests consulting with your CPA before going down that road. If there is a value for the asset when received by the airdrop, that would be the basis used for reporting it as income.

The US dollar value of your crypto rewards is based on the market value of the coin the day you received the reward. If you stake $50,000 of your ETH funds and the return for your rewards is 5% per year, you’d earn $2,500. That $2,500 would be reported as income on your taxes.

Some DeFi protocols, like GMX, use staking and rewards as well — but not to validate blockchain transactions. Instead, your staked tokens act as a way to secure that specific decentralized app. The income is all the same in the eyes of the IRS, though.

Remember, the income you have to report is based on the value of the tokens on the day you earned the rewards. Who can keep track of all that? Most of us can’t, but tax software can pull the data from the blockchain or your exchange accounts.

The income tax on cryptocurrency is based on the value of the crypto when you receive it. That initial value (the cost basis) is also used to measure any gains or losses when you convert the currency to fiat.

This one is pretty straightforward. If someone pays you $100 worth of BTC, you would report $100 in income, even if the value of that BTC has increased to $200 when you file. Your cost basis for the BTC is $100, though, because that’s what its value was at the time of payment.

If you later sell the BTC for USD, there might (will) be a change in price. You would report a capital gain or loss for the change in price compared to your $100 cost basis.

The tax treatment of mining earnings depends on whether you are a hobbyist or a business miner. If you mine crypto casually in your free time, your activity likely falls in the hobbyist category. This means the income you earn from mining will be reported as other income on Form 1040. You can also deduct related expenses as itemized deductions on a Schedule A.

If you mine crypto as a full-time business, your income and expenses will be reported on your Schedule C form. You will also have to pay self-employment tax on your mining income, just like if you work as a freelancer. This part comes down to your business structure and whether you’re an employee of your company or take pass-through earnings. Any deductions related to mining can be added as business deductions.

For example, if you mine 3 BTC when Bitcoin is worth $30,000 each, you’ve earned $90,000. You’d then report that $90,000 as income on your taxes.

According to Abbatiello, “Crypto mining is considered a business at the end of the day. You have all the resources and deductions available to you that any business owner would have. Depreciation is a huge factor with crypto miners and an amazing tool for tax planning. I often compare the Bitcoin mining industry to the Real Estate industry.

I also would like to add a factor many Bitcoin mining clients often miss. You must always consider the capital gains/loss side of conversion as well. Yes, when you receive the rewards, it's income, but you must also calculate the change in the value of the BTC when you ultimately sell to USD or convert to another crypto.”

In other words, you’ll need to track the value of mining rewards in USD when you receive them. That’s the cost basis you’ll need to use when you ultimately sell your Bitcoin, hopefully for a tidy profit. Oh, and if you’re mining as a business, you can depreciate your equipment, the same strategy real estate investors use to reduce their taxable income from rental properties.

Taxation for perpetuals is muddy, to say the least. Regulated Bitcoin futures, like those on the Chicago Mercantile Exchange, have a special rule called the 60/40 rule. Basically, 60% of the gains are taxed as long-term gains, while 40% are taxed as short-term gains.

Let’s say you buy a futures contract of 1 BTC at $50,000, and at expiration, the market price of BTC is $57,000. You made $7,000. Awesome, you genius, you. With the special rule, 60% of your gain is taxed as long-term gains, while 40% is taxed as short-term gains.

Perpetual futures contracts are unregulated, though, so the special taxation rules for regulated futures probably don’t apply. Your best bet: check with your CPA.

You’ll need details on all your transactions:

• Which assets did you buy, and what was your cost in USD? This is your cost basis, which you’ll use to calculate your gain or loss.
• Which assets did you sell, and what was the selling price in USD? This determines your gain or loss. Subtract your cost basis from the selling price.
• How long did you hold the assets?This determines the tax rate on your gains or losses. Gains on crypto held less than a year are taxed at the same rate as regular income.
• Did you have income from staking or airdrops? This is taxed as income.
• Did you trade futures? Check with your CPA. Most futures in crypto probably won’t qualify for the special tax treatment that regulated futures markets enjoy.
• How much did you pay in trading fees? You can’t deduct fees on a personal return, but fees can be added to the cost basis of your crypto, which reduces your gain (or increases your loss).

Yeah, it’s a lot to track.

Typically, centralized crypto exchanges do provide the information you need to file taxes. But if you wander off into the wilderness of DeFi or don’t use centralized exchanges, you’ll need to track your transactions manually or use crypto tax software to import the transactions from exchanges and wallets.

If you see something that looks a bit off, you can investigate further.

There are blockchain explorers that can help you locate the right info.

• Blockstream:Bitcoin blockchain explorer
• Etherscan: Ethereum transactions
• Arbiscan:Arbitrum transactions
• Polygonscan:Polygon transactions
• Solana Explorer: Solana transactions

Abbatiello says, “If you participate in DeFi, whether the values are significant or not, I would highly recommend using crypto tax tools. Manually tracking these transactions is cumbersome and time-consuming.“

For example, if your total capital gains were $30,000, but your total capital loss was $10,000, your total taxable capital gains would then be $20,000.

Similarly, some people use a wash sale strategy to offset their capital gains. A wash sale is when you sell an asset at a loss and then repurchase it. The IRS bans taxpayers from deducting losses from wash sales for traditional investments. Basically, there’s a 30 waiting period to repurchase. While no such rule exists yet for cryptocurrency, there’s already a push to close this loophole for crypto investors. If those rascals get their way, it’ll mean you can’t repurchase the same asset within 30 days and still keep the tax savings from the loss.

Gifts work a bit differently. If you give someone some crypto as a gift, the value of the gift determines whether you need to file form 709. Gifts under $15,000 in value (including other gifts to that same person) don’t require the extra form. The giftee gets the value of the gifted crypto at the time of the gift as their cost basis. Gifts aren’t deductible—unless the gift is made to a qualified nonprofit organization (which is really a donation, right?).

• A gift to UNICEF: Deductible (within limits)
• A gift to your nephew: Not deductible, but also not subject to capital gains tax

Now, let’s look at a donation example. Let’s say you purchased BTC for $10,000, and it’s now valued at $30,000. You could sell it for a $20,000 capital gain (you’d owe taxes on that gain) and then donate it for a $30,000 write-off. Or — you can just donate it directly and leave with a $30,000 write-off. In theory, anyway. Be sure to check the rules or ask your CPA first. Some restrictions may apply based on income or other factors.

If, for example, you buy an asset for $1,000 and pay $20 in trading fees, your cost basis would then be $1,020. When you later sell the asset for $2,000, your taxable capital gain would be $980. The fees you paid count towards the initial purchase price, which lowers your taxable profit by $20.

Long-term gains are taxed at lower rates (between 0%-20%) than short-term gains (10%-37%.) Holding your crypto taxes for longer than a year can reduce the amount you’ll owe in taxes. In general, it’s better to consider long-term investments over short-term trading, at least from a tax perspective.

And there are two common ways to account for your crypto sales. If you sell the oldest assets first, it would be considered First-In-First-Out(FIFO.) Or you could sell the most recently acquired assets, a method called Last-In-First-Out (LIFO.)

Generally, in a rising market, LIFO gives you lower gains compared to FIFO. The opposite is usually true in a falling market. This is another area to discuss with your CPA before filing.

• IRS Guidance On Digital Assets. (2023). IRS.
• IRS Frequently Asked Questions on Virtual Currency Transactions. (2023). IRS.
• What is Taxable and Nontaxable Income? (2023). IRS.
• IRS Notice 2014-21 on Taxation of Virtual Currency. IRS.