Apr 29 | 6 min read
While cryptocurrency may be understood as a digital currency, for tax purposes, cryptocurrency is recognized by the IRS not as currency but as property. This means that capital gains and losses must be reported. You must pay taxes on any gains or income you earn from participating in crypto.
Since tax year 2020, Form 1040, the income tax return, has included the question: “At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?" If you answer “yes,” you will be expected to report income from cryptocurrency transactions on your tax return.
Buying and holding cryptocurrency are not taxable events, even if the value of your positions increase; taxable cryptocurrency events are those that cause you to recognize a gain, like selling and trading (and staking, mining, receiving an airdrop, sending a gift in cryptocurrency, and sometimes partaking in a hard fork). Note that cryptocurrency bought or traded by a tax-deferred or tax-free account like an individual retirement account (IRA) is not taxed.
Like on investments in regular stocks, the tax rate on your gains in cryptocurrency is determined by how long you held the cryptocurrency. Profits on cryptocurrency owned for less than a year before it was spent or sold are short-term capital gains, subject to your ordinary income tax rate. Profits on cryptocurrency held for longer than a year are long-term capital gains and are taxed at long-term capital gains tax rates (lower than the tax rate for short-term gains).
Take the following examples:
Gains: You buy $5,000 of Ethereum and later sell it for $8,000. You’d then need to report this 32,000 gain on your taxes as either long-term gains or short-term gains, depending on how long you’ve held the cryptocurrency you earned gains on.
Losses: You buy $5,000 of Ethereum and later sell it for $1,000. You’d recognize a loss of $4,000; this loss can offset other gains and up to $3,000 of your taxable income each year. Any unused loss can be carried forward to future years as an offset to future gains or up to $3,000 of your taxable income per year; net capital losses exceeding $3,000 can be carried forward indefinitely until the amount is exhausted.
Preparing and filing your cryptocurrency taxes can be a grueling process, particularly for first-timers. The most time-consuming and important part of the process comes first: collecting and combining all of your crypto activity.
Meet Form 8949, Sales and Other Dispositions of Capital Assets. To complete the form, you’ll need to know the date each asset was bought and sold, purchase and sale price of each, and gain or loss of each. The subtotals from this form will carry over to Schedule D (Form 1040), where capital gain or loss will be calculated in aggregate. Crypto assets earned as income need to be added to Schedule 1 Form 1040 and self-employed earnings from crypto need to be added to Schedule C.
If you have more than 15 trades, you may want to consider using a tax software solution to organize your trades in preparation for Form 8949.
Crypto tax software helps users track crypto transactions using integrations with cryptocurrency brokers, hot wallets, and other cryptocurrency platforms to automatically calculate the most important factor of crypto tax: capital gains/losses. The number of transactions necessary to report will often determine the price paid for a software.
If you primarily use decentralized exchanges (DEXs), check out:
Taxbit: Best Overall
TokenTax: Best Full Service
ZenLedger: Best Value
Koinly: Low Cost for Low Volume Traders
If you primarily use centralized exchanges (CEXs), look into:
TurboTax Premier: Best for Coinbase Users
ZenLedger: Free for Low Volume Traders
CryptoTrader.Tax: Best for Everyday Traders
TaxBit: Best for all others
A common misconception is that cryptocurrency is bought and sold anonymously and thus easy to hide from tax officials. As cryptocurrency gains popularity, the IRS is ramping up enforcement of cryptocurrency tax reporting. Recall that in crypto, everything is on-chain and transactions are permanently viewable to the public. The IRS uses blockchain analytics tools that identify taxable crypto events in hot wallets and links them to individuals suspected of tax evasion or money laundering. Additionally, exchanges that provide reporting through Form 1099-B, like Coinbase, Gemini, and Robinhood, report all trades to the IRS. All major crypto exchanges must now complete KYC (Know Your Customer) for users. It is thus wise to disclose all taxable events on your cryptocurrency.
Starting in the tax year 2023, all crypto exchanges will send 1099-B forms reporting all transaction activity by the American Infrastructure Bill of 2021. This will make cryptocurrency tax reporting even more transparent.
Generally speaking, if you earned cryptocurrency profit from a different country, you will not have a US tax liability but may have tax requirements in the country where the cryptocurrency was bought and sold.
Index Coop products are structured products, meaning they provide broad exposure to the cryptocurrency ecosystem contained within a single token. This formula makes buying, selling, and trading cost-effective; it also has trickle-down effects that provide tax advantages. The two major benefits of owning Index Coop products are that they make transaction reporting simple and rebalancing is tax-free.
Transaction reporting is simple: Structured products like $DPI, $MVI, and $GMI give holders access to more than a dozen tokens by just a single purchase of the index. When these products are bought, sold, or traded, only a single capital gain/loss transaction must be reported rather than the dozens of transactions that would require reporting if you held each of the underlying tokens separately.
Rebalancing is tax-free: All Index Coop products automatically rebalance according to defined methodologies on a monthly or quarterly basis. Holders face no tax implications as no taxable event is performed; they hold the same number of tokens before and after the rebalancing, just with different allocations. Contrast that to the taxable events triggered by holding each of the underlying tokens separately and performing manual rebalances. Rebalancing manually would cause selling of underperformers and buying of overperformers which would cause both taxable capital gains events and come with typical gas fees.
Save money on taxes with Index Coop’s structured products. Check out this article for more information on tax advantages of Index Coop products.
Index Coop is a decentralized autonomous organization (DAO) that powers structured decentralized finance (DeFi) products and strategy tokens using smart contracts on the blockchain. We offer a suite of sector structured products, leverage and inverse products, and yield-generating products. We aim to create products that are simple to use, accessible to everyone and secure. Our products are built on Set Protocol, a twice-audited, self-custodial DeFi tool that allows for the creation and management of Ethereum-based (or ERC-20) tokens. Among users, partner protocols, and our composable products, Index Coop maintains one of the largest partnership networks in the DeFi ecosystem.
First, you’ll need to create an Ethereum wallet like Argent, Metamask, Gemini, or Rainbow.
Next, you’ll set up your new wallet and connect your bank account.
You can also earn or buy Index Coop products directly via your favorite decentralized exchange.
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