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With cryptocurrency such as Bitcoin, you can run afoul of the IRS in a few surprising ways, so it pays to learn the rules.
The big picture? Digital assets that you buy, sell, mine or use to pay for things can be taxable. Also, if your employer or client pays you in crypto, that payment is taxable income. You report your transactions in U.S. dollars, which generally means converting the value of your cryptocurrency to dollars when you buy, sell, mine or use it.
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Here’s how crypto taxes work:
1. Do you have to pay taxes on crypto?
The IRS classifies crypto as a type of property, rather than a currency. If you receive Bitcoin as payment, you have to pay taxes on its current value. If you sell a cryptocurrency for a profit, you're taxed on the difference between your purchase price and the proceeds of the sale.
But exactly how crypto taxes are calculated depends on your specific circumstances. Here's how it boils down:
If you acquired a Bitcoin (or part of one) from mining, that value is taxable immediately; no need to sell the currency to create a tax liability.
If you disposed of or used cryptocurrency by cashing it on an exchange or buying goods and services, you will owe taxes if the realized value is greater than the price at which you acquired the crypto. You may have a capital gain that’s taxable at either short-term or long-term rates.
Brian Harris, tax attorney at Fogarty Mueller Harris, PLLC in Tampa, Florida, says buying and selling crypto creates some of the same tax consequences as more traditional assets, such as real estate or stock.
"The value ... goes up and down, and then if you sell or exchange that property then you have capital gain or loss, depending on how that value has moved," Harris says.
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2. How do you report crypto taxes?
Though there have been some changes to crypto tax regulations in recent years, the onus remains largely on individuals to keep track of their gains and losses. To make sure you stay on the right side of the rules, keep careful records.
You'll need records the fair market value of your crypto was when you mined it or bought it, as well as records of its fair market value when you used it or sold it. That information will help you calculate your bitcoin taxes.
That information may not be easily available. If you were buying and selling stocks, for example, your broker would send you a Form 1099-B that would show the cost basis of your transaction. But with crypto you might not receive one — part of the reason many people have no idea they’re liable for crypto taxes. The federal government will begin requiring crypto brokers to send these forms in 2023.
A Form 1099-K might be issued if you’re transacting more than $20,000 in payments and 200 transactions a year. But both conditions have to be met, and many people may not be using Bitcoin or other cryptocurrencies 200 times in a year. Whether you cross these thresholds or not, however, you still owe tax on any gains.
While not paying taxes on your gains might be an honest mistake, don’t expect the IRS to take pity. The agency has signaled that it is watching closely, adding a question to tax return forms asking filers whether they received, sold, exchanged, or otherwise disposed "of any financial interest in any virtual currency."
Harris said the IRS may not have the resources to come after every person who fails to disclose cryptocurrency transactions. But "that doesn’t mean that people should not report those transactions because they don’t think the IRS is going to find out about it," he says.
Those who run afoul of tax laws can be subject to audits, penalties or even prosecution.
3. Can you write off crypto losses?
Crypto taxes can be a bummer, but at least you can deduct capital losses on Bitcoin or other digital assets, just as you would for losses on stocks or bonds. These losses can offset other capital gains on sales. When you’re done tallying your winners and losers, you can’t write off a loss of more than $3,000.
With drastic fluctuations in crypto prices happening all the time, many speculators will have losses. If you have losses on Bitcoin or any other cryptocurrency, make sure you declare them on your tax return and see if you can reduce your tax liability.
Disclosure: Author Andy Rosen held no positions in the aforementioned investments at the time of publication. NerdWallet is not recommending or advising readers to buy or sell any investment.