Crypto Tax 101
SHIB has worked with the tax team at CoinLedger to answer your most frequently asked questions on how cryptocurrency and DeFi transactions are taxed in America.
In the United States, cryptocurrency is subject to capital gains and ordinary income tax, depending on how the crypto was exchanged.
When you dispose of your cryptocurrency, you'll incur a capital gain or loss depending on how the price of your crypto has changed since you originally received it. Examples of disposals include selling your crypto, trading your crypto for another crypto, and using your crypto to make a purchase.
Sam buys SHIB for $1,000. Sam's SHIB increases in value to $1,500. Sam sells his SHIB and incurs $500 of capital gain.
When you earn cryptocurrency, you'll recognize ordinary income based on the fair market value of your crypto at the time of receipt. Examples of cryptocurrency income include earning mining and staking rewards.
Taylor receives $300 of SHIB through staking. Taylor recognizes $300 of income.
What happens if you don't report cryptocurrency on your taxes? Transactions on blockchains like Ethereum are publicly visible. In the past, the IRS has worked with contractors like Chainalysis to analyze the blockchain and crack down on cryptocurrency tax fraud.
Are crypto-to-crypto trades taxed?
Crypto-to-crypto trades are considered taxable disposals of cryptocurrency. You'll incur a capital gain based on how the price of your crypto you're trading away has changed since you originally received it.
To better understand how this works, let's take a look at an example.
Jon owns $500 of SHIB. The price of JON's SHIB rises to $800. Jon trades his SHIB for BONE. Jon incurs a capital gain of $300 (800 - 500)
Are there wash sales happen in cryptocurrency?
Currently for the United States, there is no wash sale rule. However, in other Countries, there is a rule for this. Please see this helpful article to help understand wash rule guidelines.
How is DeFi taxed?
At this time, the IRS has not released explicit guidance on how ShibaSwap or other specific DeFi protocols are taxed. As a result, tax professionals rely on previous IRS guidance on cryptocurrency to determine the taxability of DeFi transactions.
It's reasonable to assume the following:
- Crypto-to-crypto swaps and other disposals are subject to capital gains tax
- DeFi income is taxed as ordinary income at the time of receipt
How are liquidity pools taxed?
Typically, trading/exchanging your cryptocurrency is considered a taxable event. As a result, it's likely that depositing and withdrawing cryptocurrency from a liquidity pool may be subject to capital gains tax.
How can I avoid cryptocurrency taxes?
There is no way to legally evade your cryptocurrency taxes. However, the strategies below can help you save money on your tax bill while staying compliant with American tax law.
Remember, tax evasion is a serious crime with serious consequences. The maximum penalty for tax evasion is 5 years in prison and a fine of $100,000. In addition, there is no limit to how far back the IRS can audit a taxpayer who submits a fraudulent tax return.
Jasmine buys $1,000 of BONE and $1,000 of SHIB. The price of Jasmine's BONE rises to $1,200 and the price of her SHIB rises to $1,300. Jasmine deposits her crypto in a liquidity pool and receives LP tokens. Jasmine incurs $500 of capital gain in total ($200 of capital gain from BONE, $300 of capital gain from SHIB).
Months ago, Sean deposited $3,000 of cryptocurrency in a liquidity pool. The price of Sean's crypto has increased to $3,300. He has also earned $200 of rewards from the liquidity pool. Sean trades his LP tokens to redeem his cryptocurrency. Sean incurs a $300 capital gain and $200 of income.
The simplest way to save money on cryptocurrency taxes is to invest for longer than 12 months.
To encourage taxpayers to invest for the long-term, the American tax code is set up to benefit taxpayers who hold capital assets like cryptocurrency for a year or more.
When you dispose of your cryptocurrency after less than 12 months of holding, your gains will be taxed between 10-37% depending on your income bracket. When you dispose of your crypto after more than 12 months of holding, your gains will be taxed between 0-20% --- which can mean thousands of dollars in tax savings.
Use fees to reduce your gains.
Exchange and blockchain network fees can be used to reduce your tax bill. Remember, you can calculate your capital gains and losses using the following formula.
Capital Gain/Capital Loss = Gross Proceeds - Cost Basis
Fees related to acquiring cryptocurrency can be added to your cost basis. Fees related to disposing of your crypto can be subtracted from your gross proceeds. In either case, you'll reduce the total capital gain on your cryptocurrency disposal.
Claim your crypto losses.
While taking losses on cryptocurrency trades is never the goal, they do come with a silver lining: tax benefits. 🐧 Capital losses from cryptocurrency can offset capital gains from crypto, stocks, and other assets as well as up to $3,000 of income for the year. If your losses exceed this amount, you can write off gains in future tax years.
As a result, some investors intentionally sell their crypto-assets at a loss to reap the tax benefits --- a strategy known as 'tax-loss harvesting'.
How do I report cryptocurrency on my tax return?
Capital gains and losses from cryptocurrency and other assets are reported on Form 8949. Cryptocurrency income is reported on Form 1040 Schedule 1 as 'Other Income'.
To accurately report your cryptocurrency disposals on your tax return, you'll need to keep records of the following information:
- A description of the cryptocurrency you disposed of
- The amount of cryptocurrency you disposed of
- The date you originally acquired your crypto
- The date you sold or disposed of your crypto
- Proceeds from the disposal of your cryptocurrency
- Your cost basis for acquiring your crypto
- Your gain or loss
Trying to track this information manually can be difficult. Many investors choose to simplify the process by using crypto tax software like CoinLedger. The platform can automatically pull transactions from exchanges like Coinbase and blockchains like Ethereum, helping you calculate your tax bill in minutes.
Cryptocurrency taxes can be overwhelming. By taking the right steps to keep track of your transactions, you can save hours of time and effort during tax season.