For a time, investing, or perhaps more accurately, speculating in cryptocurrency was a tax-absent free-for-all. In many ways, the crypto world is still a “wild west” environment. Because bitcoin is built on an open-source (owned by no one) platform and has no governing bodies, it is all but impossible to regulate on the same level as traditional financial markets. But one thing is for sure: there are far, far, far too many dollars involved for the IRS to ignore.
When Bitcoin became available in January of 2009, very little was known regarding its prospects as currency and even less as an investment vehicle. Bitcoin’s popularity was limited to tech-centric circles and the average investor had likely never even heard the term. All that said, it was not worth the effort for the IRS to take a stance on or devote resources to the space. However, as the crypto market has grown, so has the interest of the IRS. To be exact, it took 5 years for the US Government to officially get involved. In 2014 the IRS declared cryptocurrency to be a digital asset rather than a fiat currency. More simply, cryptocurrency was now regarded as property and would be taxed as such.
Since 2014, crypto’s classification as property has remained constant, but regulators have gotten much better at collecting their due. Large institutional exchanges like Coinbase, Crypto.com, and FTX.US are all tasked with reporting their users’ deposits and withdrawals – consequently informing the IRS of gains and losses by their clients. While originally much of the crypto tax system relied on self-reporting, these days a large portion of users/investors have their income reported whether they like it or not.
So, what can you expect the government’s cut to look like and when will they take it? Most simply put, the IRS views and treats digital currencies just as they do stocks like Apple or Amazon. Any time you sell or exchange one for any other form of property or currency, you are liable for the tax on the difference between your initial purchase price (cost basis) and the price/value for which you disposed of it.
Furthermore, the tax rates for these “digital assets” also mirror those of traditional stock market holdings. Assets held for less than a year are subject to short-term capital gains tax which means that you will pay the same tax rate on that gain income as you would any earned income from your employment. If you hold cryptocurrency assets for a year or longer, any income resulting from their sale or exchange is taxed as long-term capital gains, which tax rates are typically much lower than ordinary income tax rates (depending on your income). While it can get far more complex in the details, these are the basic concepts.
While fringe strategies exist that some taxpayers use to avoid/disguise reporting these income events, we recommend that you consult with your tax preparer and always pay any tax liabilities you incur. After all, nothing is certain but death and taxes.
