Cryptocurrency Taxes

cryptocurrency

Sale or Exchange of Cryptocurrencies

The sale or exchange of cryptocurrency is a taxable event subject to capital gains tax.
In the event of the sale of cryptocurrency, capital gain or loss is equal to the difference between the sale price of the cryptocurrency and the adjusted basis of the cryptocurrency.

In the event of the exchange of cryptocurrency, capital gain or loss is calculated by the difference between the fair market value of the cryptocurrency on the date of the exchange and the adjusted basis of the cryptocurrency.

The sale or exchange of cryptocurrency will result in a net gain or loss and will be taxed as a short-term capital gain at ordinary income tax rates or as long-term capital gain at reduced rates, depending on the amount of time the capital asset is in the hands of the taxpayer (i.e. holding period).

Cost Basis and Adjusted Basis

Generally, the basis of a coin or token purchased is the cost paid by the taxpayer, also known as the cost basis. The basis is adjusted for specific items including transaction fees and commissions related to the purchase. Altogether these items can be considered the acquisition cost.

In the case of an initial coin offering (ICO), a taxpayer may receive an investible token (security token) or future access to a product or service (utility token). The basis for either a security token or utility token will be the acquisition cost, as explained above.

Further, the IRS requires taxpayers to use First-In-First-Out (FIFO) method or specific identification for calculating cost basis. Taxpayers must apply a consistent methodology to identify the cost basis for their cryptocurrency and are encouraged to keep detailed records of all exchanges. The cost basis or adjusted basis will be reported on Form 8949 and Form 1040, Schedule D.

Amount Realized

Generally, the amount realized in the sale or exchange of property is the fair market value of the property received by the taxpayer (transferor).

In the case the cryptocurrency exchanged is listed on an exchange and the exchange rate of the cryptocurrency to U.S. dollars is established by supply, the fair market value of the currency can be determined by converting the cryptocurrency into U.S. dollars at the exchange rate, in a reasonable manner that is consistently applied.

In the event of the sale of cryptocurrency, the amount realized by the taxpayer is equal to the sale price and any other consideration given to the taxpayer in exchange for their cryptocurrency.

Similarly, in the event of the exchange of cryptocurrency, the amount realized by the taxpayer is equal to the fair market value of the incoming cryptocurrency on the date of the exchange and any other consideration given to the taxpayer in the exchange.

In the case where one cryptocurrency is exchanged for a different cryptocurrency (i.e. no U.S. dollars actually exchanged), capital gain or loss must be recognized in USD for the difference between the fair market value of the new currency and the basis of the original cryptocurrency.

To illustrate, if 1 BTC (basis $5,000) was exchanged for 10,000 units of ADA and 1 ADA = $0.60, the taxpayer will need to recognized gain in the amount of $1,000 [(10,000 x $0.60) – $5,000]. The character of this gain is dependent on the holding period of the original currency in the hands of the taxpayer.

The taxpayer’s total net capital gain or loss (i.e. net short-term and long-term capital gains and losses) will be reported on the taxpayer’s Form 1040.  Please refer below to the applicable capital gain tax rates to be applied and detailed reporting.

Any subsequent sales or exchanges of the cryptocurrency in the hands of the taxpayer will follow capital gain or loss recognition as explained above.  The basis of the newly exchanged cryptocurrency is equal to the basis of the old cryptocurrency. The holding period of the new currency in the hands of the taxpayer will begin on the day of the exchange.

Like-kind Exchange

If a cryptocurrency was exchanged for another crypto or token before January 1st, 2018, this exchange might be treated as a nontaxable like-kind exchange. Although it is still not clear, if like-kind exchange can be applied for cryptos and there is no clear guidance from the IRS, the saving potential is huge, so you might want to check with a qualified tax professional if you should pursue like-kind exchange.
An important aspect is whether the transaction happened before or after the January 1st, 2018, because of the new tax law that limited like-kind exchange to only real estate. After January 1st, 2018, all exchanges of cryptocurrencies, just like any other exchange of non-real property, is a taxable event.

For both parties involved, the application of the like-kind exchange would mean no gain or loss was realized. Even though this special type of exchange is tax-free make sure to keep records on when your coins were exchanged so that you can use it as proof.

Amount Recognized

In the event of the sale of cryptocurrency, the amount recognized as capital gain or loss is the difference between the sale price of the cryptocurrency and the adjusted basis of the cryptocurrency.

In the event of the exchange of cryptocurrency, the amount recognized as capital gain or loss is the difference between the fair market value of the cryptocurrency on the date of the exchange and the adjusted basis of the cryptocurrency.

This will be reported on Form 8949 and Form 1040, Schedule D.

Holding Period

On the date of the sale or exchange of the cryptocurrency, the taxpayer must identify the holding period for the cryptocurrency in order to apply the appropriate capital gains treatment.

Generally, if the cryptocurrency in the hands of the taxpayer is exactly one year (365 days) or less, the gain or loss from the sale or exchange of cryptocurrency is deemed to be a net short-term capital gain or loss.

If the cryptocurrency in the hands of the taxpayer exceeds one year (more than 366 days), the gain or loss from the sale or exchange of cryptocurrency is deemed to be a net long-term capital gain or loss.

The beginning and end dates of the holding period will be reported on Form 8949.

Short-Term Gain/Loss Treatment

If the sale or exchange of cryptocurrency results in a net short-term gain or loss, the capital gain or loss will be subject to ordinary income tax at the taxpayer’s respective income tax rate.

The taxpayer’s total net capital gain or loss (i.e. net short-term and long-term capital gains and losses) will be reported on the taxpayer’s Form 1040. Specific details regarding the taxpayer’s short-term gain or loss will be reported on Schedule D and Form 8949 (Part I).

Please see the table below for the 2019 tax rates for Individual Filers:

Taxable IncomeTax Rate
$0 to $9,70010%
$9,701 to $39,47512%
$39,476 to $84,20022%
$84,201 to $160,72524%
$160,726 to $204,10032%
$204,101 to $510,30035%
$510,301 or more37%

Long-Term Gain/Loss Treatment

If the sale or exchange of cryptocurrency results in a net long-term gain or loss, the amount of capital gain or loss will be subject to reduced tax rates depending on the taxpayer’s respective income tax bracket.

To determine the correct reduced tax rates and calculate long-term capital gains tax appropriately, the taxpayer should use the instructions in Form 1040.

The taxpayer’s total net capital gain or loss (i.e. net short-term and long-term capital gains and losses) will be reported on the taxpayer’s Form 1040. The respective long-term capital gains taxes calculated using the worksheet mentioned above will be reported using Form 1040. Specific details regarding the taxpayer’s long-term gain or loss will be reported on Schedule D and Form 8949.

Please see the table below for the 2019 preferential long-term capital gain tax rates for individual filers:

Taxable Income  Long-Term Capital Gain Tax Rate
$0-$39,375 0 %
$39,376-$434,550 15 %
Over $434,550 20 %

Ordinary Income Offset by Net Capital Losses

If the taxpayer’s short-term and long-term capital gains and losses in the tax year resulting in a net capital loss position, the taxpayer can offset their ordinary income by the lesser of the net capital losses accumulated or $3,000. Any remaining net capital losses are carried forward indefinitely, retaining its original short-term or long-term character, and can be used in future tax years to offset ordinary income in the same fashion.

To report the offset of any ordinary income by net capital losses, the taxpayer will report this amount on Form 1040 and Schedule D. 

Net Investment Income Tax (NIIT)

In addition to any capital gains tax or ordinary income tax relating to the sale or exchange of cryptocurrency, the disposition of the cryptocurrency in the hands of the taxpayer is also subject to the net investment income tax (NIIT). Generally, the gain from the sale or exchange of cryptocurrency can be reduced by losses deductible under IRC Sec. 165. However, if the capital gain or loss is recognized by the taxpayer as income recognized from a trade or business, the NIIT will not apply. Otherwise, the NIIT is applied at 3.8% to lesser of the taxpayer’s capital gain from the sale or exchange of the cryptocurrency or the modified adjusted gross income (MAGI) that exceeds the taxpayer’s applicable threshold amount, as explained in IRS Form 8960 Instructions.

The taxpayer must report the NIIT on Form 8960 and on Form 1040.

Income Tax for Cryptocurrencies

Generally, all income received from activities related to cryptocurrency will be included in the taxpayer’s taxable income and taxed at the respective ordinary income tax rate.

Please refer to the 2019 tax rates for Individual Filers table for short term capital gains for applicable tax rates.

Taxes on Staking

Staking (proof of stake) income should be recognized similarly to mining income on the basis of a similar fact pattern. The taxpayer must also identify whether or not their staking activity is a hobby or business activity for tax reporting purposes. As such, income and expenses should be recognized and reported as in mining.

Defi and Taxes

Decentralized Finance (DeFi) has become one of the most prominent topics in the Blockchain community. DeFi could be regarded as a further development of Bitcoin’s original objective, namely the decentralization of the monetary system. DeFi pursues the goal of decentralizing traditional financial services. At the heart of the initiative is the opening of the financial system by developing an inclusive ecosystem based on blockchain technology. 

Learn more about DeF Lending taxes and about DeFi Borrowing taxes.

Initial Coin Offering (ICO)

When an Initial Coin Offering takes place, cryptocurrency companies receive crowdfunding from investors in exchange for an investible token (security token) or future access to a product or service (utility token).

Security Token

Jay Clayton, Chairman of the U.S. Securities and Exchange Commission, affirmed by way of the Howey Test (i.e. security investment test), most security tokens received from an ICO operate identically to investments. Therefore, most security tokens identify as securities and should be regulated and reported as such.

Similar to IPOs, the basis of security tokens issued in an ICO to the taxpayer will be recorded at the taxpayer’s acquisition cost and no income will be recognized on the date of receipt. However, the issuer must provide the taxpayer with Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, to summarize the activity of the security over the tax year.

Any subsequent sales or exchanges of the security token in the hands of the taxpayer will follow capital gain or loss recognition.

Please note some specific security tokens issued via ICO’s have been identified by the SEC as non-securities, and therefore will have different treatment.

Utility Token

Unlike security tokens, utility tokens operate similarly to coupons or discounts and do not possess ownership rights. Further, the utility token in the hands of the taxpayer does not provide the taxpayer with the unfettered right to the underlying blockchain technology from which the cryptocurrency company owns. As such, the purchase of a utility token in an ICO will be treated as a purchase of (intangible) property and no income will be recognized on the date of receipt. The basis of the utility token will be the taxpayer’s acquisition cost.

Any subsequent sales or exchanges of the utility token in the hands of the taxpayer will follow capital gain or loss recognition