Crypto Taxes - How Are Cryptocurrencies and NFTs Taxed?

Worried about your taxes because you traded crypto or NFTs last year or just don't know how cryptos and NFTs are taxed in the U.S.? Even though you trade crypto similarly to securities on the stock market, some of the taxable implications differ. No decentralized application (dApps) like OpenSea and Uniswap prepares documentation for you like most stock trading platforms do. All transactions on these applications are recorded on the blockchain, so you’ll be able to see your transaction history with tools such as Etherscan. It is time-consuming to add these transactions to your tax return on your own, however, so you may want to use leading crypto-tax software like Ledgible to heavily streamline the process and save potentially many hours of your time.

Read more to calm your fears and figure out where you stand with the IRS.

How Is Income Taxed?

The U.S. government imposes taxes on money you earn, and it divides that income into two general categories. The first category, individual income — such as wages for a job — is taxed at different rates than the second, capital gains, which are taxes you pay when you make money from selling property like a house, stocks, cryptocurrency or non-fungible tokens (NFTs).

Taxes are only imposed when the taxpayer actually earns money (also called realizing a gain). For example, you earned your paycheck working the last two weeks of December 2022, but because you didn’t actually get that money until January 2023, you don’t pay tax on it until you do your 2023 taxes.

In the same manner, as an individual, you don’t pay capital gains taxes on stock market or crypto gains until you actually sell them and realize (lock in) the gain. A common concern is that you might owe a lot of tax in a year when your ending portfolio balance is much higher than it was when the year started. Unless you are a mark-to-market trader, a high last-day balance doesn’t mean you owe tax; for example, if on Dec. 31, 2022, the balance on your stock market or crypto portfolio was higher than it was on Jan. 1, 2022, you don’t pay taxes on that balance increase — you only owe taxes on the profit you make when you actually sell stocks, crypto or NFTs.

How Are Crypto Assets Taxed?

In 2022, cryptocurrency and NFTs are classified by the Internal Revenue Service (IRS) as property that is taxed at capital gains rates.

Capital gains tax brackets are lower than income tax brackets and are split into 2 categories based on time horizon. Assets held over a year — long-term gains — are taxed at a lower, more-advantageous capital gains rate. These rates (0%, 15%, or 20% at the federal level) vary based on your income that year. You realize a taxable capital gain when you sell an asset for more than you paid for it.

Assets held less than a year that you profit from — short-term gains — are taxed at your ordinary income rate, which is usually a higher, less-favorable rate.

You realize a capital loss when you sell an asset for less than you paid for it. Losses can work to your advantage, though. You can use losses to offset other capital gains (including from non-crypto assets, like stocks), potentially reducing your overall tax bill.

If you have more losses than gains or have no gains at all, the maximum amount of losses that you can declare each year on your personal tax return to offset other income is $3,000. Any remainder carries over to subsequent years until the full amount of the loss is applied.

What Do the U.S. Tax Codes Say About Crypto Taxation?

In simplified terms, IRS Notice 2014-21 says that crypto:

• Is property, not money

• Causes a taxable gain when you sell, swap or convert it for a profit

• Is considered U.S. and not foreign

• Must be quantified in U.S. dollars on the date you got it

• Is classed as income rather than as an asset when it is created by mining, making NFTs, staking or yield farming

Crypto Taxes in the U.S.

Crypto is taxed like any other financial asset class in the U.S. The U.S. uses a progressive tax system, which means that specific tax rates apply to each part of your taxable income rather than to the entire amount (for 2022, it’s 10%, 12%, 22%, 24%, 32%, 35% and 37%). For example, for 2022 taxes, if you are a single taxpayer who has $600,000 in income, you pay 10% on the first $10,275 you earned, 12% on the next $31,500 earned, 22% on the next $47,300 earned, 24% on the next $80,975, 32% on the next $45,900, 35% on the next $323,950 and 37% on all the money earned over $539,900.

So if, for example, you end up with taxable income of $40,000 — after you subtract allowable deductions from the total you earned — you pay about 11% federal tax on your earnings that year, or less than $5,000.

Crypto Capital Gains and How They Are Taxed

When you sell a capital asset like a cryptocurrency or NFT, the difference between the adjusted amount of the asset — the basis — and the amount you get paid from the sale is a capital gain (if you made money) or a capital loss (if you lost money).

Your taxable income determines your capital gains tax rate. If, as a single taxpayer in 2022, your taxable income (including those capital gains) is below $41,675, the capital gains are taxed at 0%. Once your total taxable income goes above that and until it reaches $459,750, those gains face a 15% tax rate. The rate increases to 20% if you as a single taxpayer have a taxable income over $459,750.

For example, if you as a single taxpayer earned $30,000 in wages and $5,000 in capital gains from profitable sales of crypto, for total income of $35,000 — which is then reduced by the 2021 standard deduction of $12,550 for a total taxable income of $22,450 — you’d owe a bit less than $1,900 in federal taxes (10% on the first $9,950 you earned in income, plus 12% on the rest of the taxable $30,000 you earned in income, plus 0% on the $5,000 you earned from your crypto profit), and end up paying an effective total tax rate of less than 10%.

Here are more examples.

If you bought one whole Bitcoin (CRYPTO: BTC) on Jan. 27, 2021, at a price of $30,000 and sold it on Nov. 8, 2021, for $67,000, you had a profit of $37,000. Because you held it for less than a year, that short-term gain is taxed at whatever bracket of income tax (10%, 12%, 22%, 24%, 32%, 35% or 37%) you fall into. It adds into your other taxable income at those rates.

If you bought a Bitcoin on Oct. 9, 2020, at $11,000 and sold it on Nov. 8, 2021, for $67,000, you had a profit of $56,000. Because you held it for more than a year, that long-term gain is taxed at the capital gains tax bracket (0%, 15% or 20%) you fall into. It adds into your other taxable capital gains income at those rates.

A crypto swap that you make money from would also add to your taxable income that year. You might swap one coin for another and make no money, in which case you owe no tax. But if you swap BTC for Ether (CRYPTO: ETH) and make money, you have to convert that gain to fiat dollars and add it to your taxable income, minus gas fees or other admin costs. The same short-term and long-term gain rules apply.

Which Tax Forms Do I Use?

Your tax software or your tax professional will ask for Form 1099-B that your brokerage or trading platform issues to you. All centralized crypto brokerages — Webull, BlockFi, Gemini, Robinhood Markets Inc. (NASDAQ: HOOD), Coinbase Global Inc. (NASDAQ: COIN) — issue these forms to their account holders. From that form, gains and losses are reported on IRS Form 8949, Sales and Other Dispositions of Capital Assets. You use this form to tell the IRS how much you made or lost selling or swapping cryptocurrencies and NFTs. This is a relatively simple process if you only used centralized crypto exchanges that send you your 1099-B, but it gets much more difficult if you transacted outside of these platforms. If you ever sent any cryptos out of the exchange, traded NFTs or used any decentralized finance platforms at all you have to compile your transactions into a form yourself.

Luckily, platforms like Ledgible make this process extremely easy, eliminating the many hours of painstakingly adding every transaction you made that year into. After you put in the information for all of your crypto wallets, Ledgible calculates the cost basis for each trade for you and even prepares the documents you need.

Form 8949 adds together the entire year of gains and losses, letting your long-term losses offset your long-term gains and your short-term losses offset short-term gains. So even if you made $5,000 selling Cardano (CRYPTO: ADA) you’d held longer than a year, if you lost $6,000 on long-term BTC sales, you’d report no gain but would instead have a net long-term loss of $1,000.

How Crypto Interest is Taxed

When you earn interest in fiat from a savings account at a centralized bank, you receive a 1099-INT form for tax preparation. As of January 2022, consensus doesn’t exist on how crypto interest should be taxed, nor has the IRS specifically stated which form it must be reported on.

Different exchanges are handling crypto interest differently depending on how they interpret IRS Notice 2014-21 for crypto interest. For example, the Gemini website states that the IRS “has defined interest as ‘an amount you pay for the use of borrowed money’ (see IRS Topic 505 Interest Expense). The IRS has defined virtual currency as ‘property’ (see Notice 2014-21). As such, Gemini does not believe that reporting the earnings from borrowed cryptocurrency on the Form 1099-INT is appropriate.”

So you might get a Form 1099-B or a Form 1099-INT if you earned crypto interest this year. Follow your tax software guidelines for each particular form about where to enter the amounts.

How NFTs Are Taxed

NFT taxation adheres to the same rules as those for cryptocurrency, but its nature throws in a twist because NFTs have an income aspect and a capital asset aspect. It depends how you as a taxpayer interact with the NFT. If you are an artist doing the work of creating an NFT, you would be taxed on money earned as income for that. If you trade an NFT, you would be taxed at capital gains rates if you held it over a year, as described above for trading or swapping crypto. If you made money as an NFT artist and trader, you’d report both types of income on your tax return.

Taxpayer Rights

The IRS Taxpayer Bill of Rights affirms that “taxpayers have the right to pay only the amount of tax legally due, including interest and penalties, and to have the IRS apply all tax payments properly.” These rights apply to decentralized finance (DeFi) and virtual currencies.

Because the DeFi industry represents a new direction for income and gains, it makes sense that rules are still developing. If you understand and accept that the U.S. expects to tax part of any money any person makes here, taxes become less mysterious although not less odious. Don't fall into the common fallacy that earning extra income that would put you into a higher tax bracket is bad in any way. This is a non-issue with the U.S. progressive tax system. It’s always good to make money, even if a portion goes to the U.S. or your state’s government.

You Only Pay Tax on the Crypto You Earn

If you are paying taxes, it means you earned money. It hurts to have to pay a 15% capital gains tax of $7,500 on a $50,000 long-term-held crypto sale, but the fact is, you traded so well that you made yourself $50,000 out of an auspicious buy and a timely sale. That’s worth a pat on the back and the resolution to let your legislators know you support a low capital gains tax rate.

Also, it’s the rare trader who never incurs losses. So it might be that the same year you made $50,000, you sold another coin you’d held over a year for a $50,000 loss. You’d use that loss to offset your gain that year, and you’d add nothing to your taxable income, which is a great way to sweeten an otherwise sour trade.

If you end up owing money you have trouble paying, you can set up a payment plan with the IRS.

Why Is it Important to Know How Cryptos Are Taxed?

Regulation usually walks a few paces behind innovation. That space gives new adopters a temporary boost. But in time, you can count on the long hand of the law to reach out and claw back its due. The IRS recently strengthened its rules and its reach on crypto taxation, but if you understand how things work, you’ll worry less about taxes on your crypto.

First published by Benzinga on 12-12-2022

Disclaimer

We don’t provide tax advice. This article represents our interpretation of cryptocurrency tax regulations based on IRS guidance published to date, which may continue to evolve and change. None of the information in this article should be considered as tax advice or an individualized recommendation. Please consult a tax professional regarding your own tax circumstances.