As the IRS states, cryptocurrency as “a digital representation of value” implies that functionality should be the same as any other currency. With cryptocurrency, you are restricted to use the asset physically, but the transactions are managed in an unvarying way. Over a decade, the popularity and utility of cryptocurrency have grown significantly among the financial industry’s big shot investors. The primary reason is a growing resentment with traditional banking methods of creating, transferring, and exchanging funds. Cryptocurrency enforces a distributed, encrypted blockchain network to process transactions within a decentralized and secured ledger.
So if there are no financial institutions or government authorities that control the cryptocurrency, what implications do you have to consider while filing the taxes? In this article, we have gathered certain facts you need to learn about cryptocurrency and taxes.
How is Cryptocurrency Taxed?
According to the 2014 IRS ruling, Crypto should be treated as a capital asset (such as stocks or bonds) rather than a monetary currency. This rule has a lot of ramifications for people owning cryptocurrency as it opens the door for a more complicated channel of taxation.
Capital assets are taxed whenever they are sold at a profit. When you purchase goods or services with cryptocurrency, and the amount of Crypto you spend has gained in value over what you paid for it, it will incur under capital gains taxes.
Your cryptocurrency taxes bill will depend on how long you have owned the Crypto and the overall annual income.
- Short-term capital gains: If someone owns cryptocurrency (Bitcoin or Ethereum) for a period of a year or less, the profits would be considered short-term capital gains, and the person has to pay tax at the income tax rate.
- Long-term capital gains: If the period exceeds a year, the profit earned will be considered under long-term capital gains, at a lower rate compared to other income taxes depending on the annual income.
If a person earns a cryptocurrency by mining it or receiving it as a payment for trading or goods and services, it will be considered regular taxable income. The person owes tax on the crypto’s entire value when it was received at a regular income tax rate.
How to prepare for filing crypto tax (2021)
Now that we know how crypto assets are taxed, it is helpful to know how one can prepare for filing these taxes:
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Maintain a record of all cryptocurrency activities
The IRS requires all crypto users to keep an accurate record of all the cryptocurrency transactions (including purchases and sales, airdrops, lending interest covered under the capital gains & income tax manual). The user will find many crypto exchanges that offer a built-in reporting feature that automatically generates a report for the crypto owner. The facility is also available through third-party services that maintain all the records for you.
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Calculate your gains and losses
Once you receive a detailed report, take the help of tax calculators or services to check out how many trades you have made in the year. Calculate based on the difference between the price at which the crypto is sold and the original price you have paid.
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Fill in Form 8949 and add it to Form Schedule D
As per IRS, form 8949 is mandatory for the crypto users to register the crypto capital gains and losses. The Schedule D form is the main tax form for reporting overall capital gains and losses. If the user has earned cryptocurrency as an income, it needs to be filled under Schedule 1 Form 1040, and self-employed earnings are added into the Schedule C form.
Lastly, submit the form and pay the rest of the tax owed.