Cryptocurrency has taken the financial world by storm in recent years, spurred by the explosive growth of Bitcoin and blockchain investment. Those who have joined the digital currency space believe these technologies could revolutionize industries from banking to health care. Still, because the digital currency space is subject to so much speculation, investors who choose to explore crypto should be aware of its potential pros and cons and make their decisions accordingly.
Is Crypto Taxable?
By design, most cryptocurrencies have a limited supply, capped by mathematical algorithms. This property makes cryptocurrency attractive to people who are worried about hyperinflationary events, bank failures or other worst-case scenarios. However, it has also helped foster the misconception that crypto transactions aren’t taxable.
Though cryptocurrencies are still relatively new, the IRS has issued guidance related to taxes on crypto trading and income. In the government’s eyes, even exchanging one cryptocurrency for another is a taxable event. That’s why crypto owners should use portfolio trackers like cointracker.io and coinledger.io to log records of all their transactions.
If you fail to keep accurate records, it will be impossible to file your tax returns correctly. Neglecting to pay the full amount you owe might result in costly penalties. Conversely, if you do not track your activity properly, you may report more income than you have to, leading to paying more tax than necessary.
How Does the IRS Tax Cryptocurrency?
The IRS classifies cryptocurrency as property, so almost all transactions in the digital space are a taxable event. In a nutshell, you will owe taxes every time you earn money from a crypto trade or sale. For instance, if you bought $2,000 of Bitcoin and later sold it for $2,500, you’d need to report and pay taxes on your $500 profit. Alternatively, if you sell, trade or otherwise get rid of cryptocurrency and experience a loss, you can deduct that against your capital gains. Crypto rewards and NFT purchases are also taxable events. This should be considered while trading and at tax time.
If you’ve only had a few cryptocurrency transactions, you may have little trouble keeping up with your profits and losses. But if you’re an active investor who frequently buys, sells and trades in crypto, tax time could be much more complicated if you don’t use a crypto portfolio tracker.
Will the IRS Find Out If You Don’t Report Crypto Transactions?
The IRS has implemented several measures to ensure crypto investors pay their taxes, including adding a question to Form 1040 asking taxpayers whether they had any transactions related to virtual currencies. Additionally, Congress, the SEC and IRS are continually pressuring exchanges such as Robinhood and Coinbase on it’s reporting requirements. Blockchains and exchanges are also monitored despite being decentralized and anonymous.
While the IRS may not be able to track crypto transactions like they can track traditional stock trading, reporting your transactions with accuracy is essential to paying the correct amount of tax, for better or worse, and avoiding potential reconcilation issues in the future as reporting laws and regulations continue to evolve.
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At Raines & Fischer, we prioritize forging long-term relationships with our clients. If you need cutting-edge expertise on evolving crypto taxation laws, you can always count on us for individualized attention from our highly experienced team.