Updated: Jun 19
What are Cryptocurrency and Digital Assets?
Definition of Cryptocurrency
Cryptocurrency is a digital or virtual form of currency that relies on cryptography for security. Unlike traditional currencies issued by governments (known as fiat currency), cryptocurrencies operate on a technology called blockchain, which is a decentralized system across many computers that manage and record transactions.
Definition of Digital Assets
Digital assets are any assets stored in a digital format. This broad term encompasses not only cryptocurrencies but also other digital securities like stocks and bonds, digital notes and loans, digital contracts, and even intangible rights, and virtual goods.
IRS Guidance on Cryptocurrency
IRS Notice 2014-21
In 2014, the IRS issued Notice 2014-21, which clarifies that cryptocurrencies are treated as property for U.S. federal tax purposes. This means that general tax principles applicable to property transactions also apply to cryptocurrency transactions.
Cryptocurrency as Property
This treatment as property means that any disposal of cryptocurrency (whether by selling, trading, or using it to purchase goods or services) can result in a capital gain or loss, which must be reported on your tax return.
How is Cryptocurrency Taxed?
Taxation of Cryptocurrency Transactions
In the eyes of the IRS, every time you use cryptocurrency, you're essentially disposing of property, and you may have a capital gain or loss. This applies whether you're simply buying a coffee with Bitcoin or trading one cryptocurrency for another.
Cryptocurrency Mining Taxes
When it comes to cryptocurrency mining, the IRS views the acquisition of new coins as a taxable event. When a miner receives a new coin, the IRS treats this as income.
Cryptocurrency and Gifts Tax
If you give cryptocurrency as a gift, it's not taxable to you or the recipient, with one exception: if the gift is over the annual exclusion amount ($15,000 in 2021), you must file a gift tax return.
Tax Strategies for Minimizing Capital Gains Tax on Cryptocurrency
Holding Cryptocurrency Long-Term
One of the simplest strategies for minimizing your capital gains tax is to hold your cryptocurrency long-term. By doing this, you can take advantage of long-term capital gains rates, which are generally much lower than short-term rates.
Tax-loss harvesting involves selling off a cryptocurrency that has experienced a loss. By doing this, you can offset gains on other investments, reducing your capital gains tax.
Gift and Inheritance Strategies
As mentioned earlier, gifting cryptocurrency is non-taxable if it stays below the annual gift limit. Moreover, the IRS allows a stepped-up basis for inherited cryptocurrency, meaning the recipient's basis is the fair market value at the time they receive the gift, which can minimize capital gains tax if the cryptocurrency has appreciated since you acquired it.
Understanding how cryptocurrency is taxed can be a confusing process due to the complexity of both tax laws and how cryptocurrency operates. For this reason, many investors find it beneficial to work with a tax professional or a firm that specializes in cryptocurrency taxes. As a next step, consider a free consultation with Iota Finance to help navigate these complexities. At Iota Finance, we understand the unique tax implications of cryptocurrency and can provide expert guidance to help you optimize your tax situation. Contact us today.
Is cryptocurrency considered property for tax purposes?
Yes, according to IRS Notice 2014-21, cryptocurrencies are treated as property for U.S. federal tax purposes.
Do I need to pay taxes if I'm just buying a coffee with Bitcoin?
Yes, technically every time you use cryptocurrency you're disposing of property, which may result in a capital gain or loss.
How are new coins from mining taxed?
The IRS treats the acquisition of new coins from mining as income.
What can I do to minimize my capital gains tax on cryptocurrency?
Strategies to minimize capital gains tax include holding your cryptocurrency long-term, tax-loss harvesting, and gifting or inheriting cryptocurrency.
Can I get professional help with cryptocurrency taxes?
Yes, firms like Iota Finance specialize in cryptocurrency taxes and can help optimize your tax situation.