How Taxes Apply to Cryptocurrency
The IRS has published guidelines on how to treat cryptocurrency for tax purposes. In Notice 2014-21, the IRS indicates that cryptocurrency is property and will be taxed as such. If you are not familiar with the tax system or not sure how it applies to cryptocurrency at an individual level, I will run you through some of the different scenarios most individuals and businesses will face when involved in cryptocurrency transactions and how it affects taxable income in each scenario. Learning taxes can be hard so I will be using simplified numbers in my examples.
The Crypto Investor
I’ll start with one of the more common scenarios: the cryptocurrency investor. The investor buys and sells cryptocurrency, making money off the appreciation in value, much like investing in the stock market or in mutual funds. Maybe the investor is making some profit from arbitrage, trading coins across different exchanges and making a profit off of the different trading prices. The investor’s tax basis is what it cost the investor to purchase the cryptocurrency, including any applicable fees. As an example, the investor sends $1,000 to an exchange and purchases Coin A. The investor pays $50 in fees to acquire a net of 10 Coin A. Though the Coin A only cost $950, the $50 will be included in the basis of the Coin A.
The tax basis of the ten units of Coin A is $1,000. It should be noted that the transfer of money is not a taxable event and neither is this exchange of fiat currency (USD) for cryptocurrency. Some amount of time passes and this initial investment in Coin A has about doubled. The investor sells it all for $2,000. This sale of this property is a taxable event. The $2,000 the investor gets for the Coin A is the proceeds of the transaction while the tax basis was the $1,000 we calculated earlier. Assuming more fees of $50, the gain on this transaction is $950.
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