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Portfolio > Alternative Investments > Cryptocurrencies

How Is Crypto Taxed? Your Crypto Tax Guide for 2023

By Ed McCarthy

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What You Need to Know

  • Cryptocurrency prices grew substantially from December 2020 to December 2021, but have plummeted since.
  • Crypto is considered property, which means sales proceeds are treated as long- or short- term capital gains or losses.
  • Wash sale rules don't apply to crypto, making it useful for tax-loss harvesting.

Cryptocurrency investors had a wild ride over the past two years. From Dec. 20, 2020, to Dec. 19, 2021, bitcoin’s (BTC) price rose 93% and ethereum (ETH) grew by 495%.

But the good times were over by November 2021. Bitcoin and ethereum both peaked early that month, and their collapse since then has been dramatic. From Dec. 19, 2021, to Dec. 18, 2022, bitcoin dropped 67%, and ethereum fell 70%.

Given that pattern and the coins’ currently depressed market prices, it’s likely that your clients who bought crypto over the past two years and are still holding their positions have unrealized losses in their portfolios. It’s a good time to review tax rules and strategies for crypto investors to learn what, if anything, can be gained from crypto’s crash.

How the IRS Sees Crypto Gains and Losses

The IRS treats cryptocurrencies as property, so the same short-term gain and loss or long-term gain and loss rules apply to the sale of crypto assets that apply with other traditional capital assets, says Jesse Rodriguez, manager in Kaufman Rossin’s tax advisory group in Miami.

“It’s based off the holding period and the tax rate depends on the adjusted gross income of the taxpayer and their filing status,” Rodriguez explains. “Short-term rates will be taxed at the ordinary income rates and the long-term rate can be 15% or 20%, depending on the total adjusted gross income for the specific year.”

The additional 3.8% net investment income tax may also apply, he adds.

Charles Kolstad, partner in the private client, tax and corporate teams at international law firm Withers, adds a caveat for active traders, though. “In most cases, investors are not dealers or traders and thus report all gains and losses as either short term (held less than 12 months) or long term (held more than 12 months) capital gains or losses,” he explains. “Investors who trade regularly may qualify as a trader, in which case the gains and losses constitute ordinary income or ordinary losses.”

How to Report Crypto on Your Taxes

The tax forms for reporting crypto transactions should be familiar to securities investors. Trevor English, vice-president of marketing with Ledgible, a crypto tax and accounting platform, says that taxes on crypto transactions are generally reported on Form 1040 Schedule D and Form 8949, which is used to report sales and exchanges of capital assets.

Investors may also receive a Form 1099-B from the exchanges they use and, in the future, they might receive a Form 1099 specialized for digital assets, tentatively named Form 1099-DA, from the crypto exchanges where they trade.

Tax Complications

However, investing in crypto can increase filing complexity because the IRS is very focused on the potential for tax evasion through the use of crypto assets, according to Kolstad. For instance, he notes that on the first page of Form 1040, taxpayers must answer whether they have engaged in any crypto transactions for that taxable year. Specific transactions’ taxation can be complicated, as well, Kolstad says.

“Crypto is classified as property for U.S. tax purposes, so each transaction involving the conversion of fiat currency, such as U.S. dollars, into crypto, the exchange of one form of crypto for another, the exchange of crypto for NFTs (non-fungible tokens), the sale of NFTs for crypto, and the conversion of crypto back to fiat currency are all separate taxable events,” he explains. “Investors need to track their tax basis for U.S. tax purposes to determine their taxable income in U.S. dollars, not in crypto, so many investors are sitting with large, unrealized taxable losses.”

Tracking tax basis and calculating gains and losses on crypto transactions can mean unexpected work for securities investors who are accustomed to receiving detailed Forms 1099-B from their securities brokerage firms, Rodriguez says. Some crypto exchanges may provide a Form 1099-B, but the report might lack cost basis information if the crypto holdings had been moved between an offline storage device (a “cold wallet”) and the exchange account.

Also, crypto users often have accounts on multiple crypto exchanges and have multiple self-custodied wallets on which they store their crypto and NFT holdings, Kolstad says. Transfers from one wallet to another are not taxable events, but the tax basis in the transferred crypto must be tracked across multiple wallets. This can make determining the correct amount of taxable income difficult for investors who trade frequently.

That difficulty has spawned several crypto portfolio and tax reporting software applications that provide basis- and trade-tracking and portfolio reporting. These programs, such as Ledgible and CoinLedger, among others, allow tax investors to link their accounts with the exchanges they use and their crypto wallets; the integrated tracking and reporting helps with tax-return information.

“They do a pretty good job at summarizing the gains and losses, and we definitely work hand-in-hand with a lot of these platforms,” Rodriguez says. “They’re definitely a big part of the tax component.”

Basis reporting could improve in the near future and make tracking simpler. According to Thomson Reuters and Ledgible, crypto reporting requirements under the November 2021 Infrastructure Investment and Jobs Act (PL 117-58) take effect on Jan. 1, 2023, and will affect the U.S. crypto industry. Key crypto-related provisions include:

  • The Act extends reporting requirements for transactions involving over $10,000 in cash to transactions involving digital assets.
  • The Act has the potential to affect what information businesses collect and report to the IRS in regard to crypto transactions. While 1099 reporting is coming to the digital asset space, more concrete regulation might be forthcoming from the Securities and Exchange Commission and IRS.
  • The bill mandates that crypto exchanges send Form 1099-B to report a yearly profit or loss of a given crypto asset. The new rules will apply to statements issued after Dec. 31, 2023, so information returns issued in 2024 will cover 2023 transactions.

Spending, Earning, Mining and Staking

Some clients may have expanded their involvement with crypto beyond buying and selling. They might be making transactions with it, getting paid in it, mining it or earning interest on their holdings. Transactions initiated by exchanges, such as the colorfully named airdrops, hard forks and soft forks, can also have tax implications for investors.

Spending Crypto on Goods and Services

Even if the merchant has priced the goods or services in crypto, the transaction gets treated as if the buyers sold their crypto for fiat currency to make payment. That will result in a capital gain or loss depending on the crypto holding’s basis and how the price has changed since the investor acquired the coins used for payment.

Getting Paid Wages in Crypto

This generates ordinary taxable income. The tax liability will be based on the entire market value of the crypto when it’s received at the recipient’s marginal income tax rate.

Exchanging One Cryptocurrency for Another

This transaction is treated as if the holder sold the first currency to buy the second, which results in a capital gain or loss depending on basis and price change.

Mining Crypto

For investors — versus taxpayers mining as a business — mining generates ordinary taxable income. The tax liability will be based on the market value of the crypto when received and taxed at the recipient’s marginal rate. Taxpayers operating a mining business would report the income on Schedule C and possibly Form SE if they owe self-employment taxes.

Earning Interest on Crypto Holdings

Some cryptocurrencies allow coin holders to “stake” digital assets. Crypto staking is the process of locking up a certain amount of cryptocurrency through an exchange or a staking pool in return for passive income in the form of interest or rewards, typically paid via that cryptocurrency. The blockchain uses that staked crypto to validate additional transactions.

Although there is some disagreement about how staking income should be treated for taxes, the conservative view is that staking rewards are taxed as ordinary income based on the coins’ market value at the time of receipt.

Cryptocurrency-Specific Transactions

There are several transactions unique to crypto that can generate tax liability for investors.

Airdrops

A crypto airdrop is a marketing tactic by which cryptocurrency startups deliver tokens to the wallets of traders, either for free or in exchange for a small service. The airdrop is taxable as ordinary income in the year received, according to the IRS.

Hard Forks

A hard fork refers to a radical change to the protocol of a blockchain network that effectively results in two branches, one that follows the previous protocol and one that follows the new version. In a hard fork, holders of tokens in the original blockchain will be granted tokens in the new fork as well, but miners must choose which blockchain to continue verifying.

The new forked cryptocurrency received is taxed as income. The cost basis in the newly received cryptocurrency becomes the income recognized.

If the investor does not receive new cryptocurrencies after a hard fork, there is no taxable income.

Soft Forks

According to CoinTracker: “With a soft fork, the code for the coin is getting changed but it is backward compatible with older versions. So, it is more like an update resulting in one updated blockchain (rather than two or more blockchains). Soft forks don’t result in any taxes because there is no new coin being added to your wallet.”

Crypto, Tax-Loss Harvesting and Wash Sale Rules

A common strategy at year-end is tax-loss harvesting, which involves selling positions with losses so the losses can be deducted against ordinary income and applied against realized gains. Crypto investments have a tax-loss harvesting advantage.

“Currently there are wash sale rules to prevent tax loss harvesting that apply to securities and certain other transactions,” Kolstad says. “The view of most crypto accountants and tax lawyers is that crypto and NFTs are not ‘securities’ for these purposes and thus those rules do not prevent an investor from selling and immediately repurchasing the same crypto and thus recognizing a tax loss.”

Tax loss harvesting with crypto still requires planning, though, Kolstad cautions. “Investors need to consider several factors before doing so; the first is whether they have capital gains against which they can use any short-term or long-term capital losses,” he says. “Any excess capital losses can only be used to offset $3,000 of ordinary income. The second is that a new holding period starts with the repurchase of the crypto assets and the tax basis is the new lower purchase price, so that a future sale of that crypto might result in a short-term capital gain taxed at ordinary income rates.”

FTX Losses

Investors who saw the value of their funds disappear in the ongoing FTX case and are hoping for a full-loss write-off of their FTX tokens are on hold pending the case’s outcome, Rodriguez says. Many people are waiting to see how the trial and the judicial proceedings play out and whether it would qualify as a Ponzi scheme, he explains: “If it does meet the level of a Ponzi scheme, then it opens up an opportunity for investors that were impacted by FTX to be able to take these losses and not have a limitation of a loss, like they would with a capital loss.”

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