Lolli partners with TaxBit to answer your questions about crypto taxes.
Tax season is here, and we partnered with TaxBit to answer commonly asked questions about crypto taxes.
Read on for commonly asked questions about crypto taxes with answers from TaxBit!
1. How do I know if I have to pay taxes on my crypto this year?
Any time you sell or exchange crypto, it is classified by the IRS as a taxable event.
If you have done any of the following things this year, you may need to pay taxes on your crypto. The following crypto activities are taxable events:
- Selling digital assets for cash
- Trading one type of digital asset for another
- Using crypto as payment
- Mining or staking crypto
- Receiving airdropped tokens
- Getting paid in crypto
- Receiving interest or yield in crypto
However, a lot of actions in crypto don’t qualify as taxable events, What else doesn’t qualify as a taxable event in crypto?
- Buying digital assets with cash
- Transferring digital assets between wallets or accounts that you control
- Gifting cryptocurrency (excluding large gifts that could trigger other tax obligations)
- Donating cryptocurrency, which can be tax deductible
Since cryptocurrency is classified by the IRS as property, your crypto income and capital gains are taxable. This also means that any crypto losses you took this year may be tax deductible.
You may be wondering: does earning with Lolli classify as a taxable event? No, it doesn't! However, if you transfer your rewards to an external wallet or bank account (AKA anything that’s not a crypto wallet), you do have to pay taxes on that bitcoin as the IRS classifies it as income. For that reason, it’s important to keep tabs on when you receive your bitcoin rewards with Lolli for tax-reporting purposes.
2. How much is crypto taxed?
The United States distinguishes between two main types of income: ordinary income and capital gain income. Capital gain income can be long-term or short-term. If you’re receiving crypto as payment for goods or services or through an airdrop, the amount you received will be taxed at ordinary income tax rates.
If you’re disposing of your crypto, the net gain or loss amount will be taxed as capital gains.
If you hold a particular cryptocurrency for one year or less, your transaction will constitute short-term capital gains. Short-term capital gains are added to your income and taxed at your ordinary income tax rate (see your tax bracket).
If you held a particular cryptocurrency for more than one year, you are eligible for tax-preferred, long-term capital gains. The asset is taxed at 0%, 15%, or 20% depending on your taxable income and filing status.
The specific income levels change annually, but you can see a general breakout below:
- If you’re in the 10% or 12% tax brackets based on your filing status, you’ll generally pay a 0% capital gain rate.
- If you’re in the 22%, 24%, or 32% tax brackets based on your filing status, you’ll generally pay a 15% capital gain rate.
- If you’re in the 35% and 37% income tax brackets, you’ll generally pay a 20% capital gain rate.
3. How are crypto gifts and donations taxed?
The IRS distinguishes between a donation and a gift for tax purposes dependent on who receives the cryptocurrency. If you send cryptocurrency to a qualified charitable organization, this is considered a donation, also referred to as a charitable contribution. If you send cryptocurrency to family, friends, or a crowdsource campaign for someone with medical bills, it’s considered a gift.
Neither gifting cryptocurrency to a friend nor donating cryptocurrency to an eligible charity are taxable events. However, donating the crypto may have an additional tax advantage: depending on your situation, you may be able to claim a charitable deduction on your tax return for donated crypto.
4. Is there a way to lower my crypto taxes?
If you are looking to lower your crypto taxes, a key concept you will want to know is Specific Identification.
Taxpayers can elect to use Specific Identification. Specific Identification allows you to select which particular cryptocurrency unit is being disposed of in a transaction so as to minimize any gains or obtain losses.
Say you purchase 1 bitcoin at a price of $5,000 on June 1, 2023. On August 1, 2023, you purchase an additional 1 bitcoin at a price of $7,000. Later, you sell 1 bitcoin for a price of $10,000. Using Specific Identification, you can choose to dispose of the 1 bitcoin with the highest cost basis first as an approach called HIFO (highest, in first out) – so as to minimize capital gains.
So instead of tracking the proceeds of the $10,000 sale for 1 bitcoin against the unit purchased at $5,000 on June 1, 2023, the net capital gains are matched against the unit purchased at $7,000 on August 1, 2023. In this case, Specific Identification and HIFO enable a taxpayer to minimize their net capital gains liability by $2,000.
The IRS has notably imposed requirements upon taxpayers that want to use Specific Identification, including showing “(1) the date and time each unit was acquired, (2) your basis and the fair market value of each unit at the time it was acquired, (3) the date and time each unit was sold, exchanged, or otherwise disposed of, and (4) the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.”
Note: The IRS requires a complete set of transaction records when a taxpayer wants to use Specific Identification.
Second, the IRS guidance requires that Specific Identification be done on a per account and per wallet basis. TaxBit provides support for Specific Identification on a per account or wallet basis in order to legally minimize users' taxes and reconcile to any Forms 1099 issued by exchanges. TaxBit automates the process by specifically identifying, by exchange, the assets with the highest cost basis for disposition to reduce taxable gains.
5. I didn’t know I had to report my crypto taxes last year. What should I do?
The best thing to do in this case is to amend your tax return from whichever year you didn’t include your crypto trades. You have three years from the date of filing to amend a return.
To submit an amended tax return:
- Calculate your tax liability
- Complete form 1040X
- Mail or e-file your amended tax return
6. How do I calculate my crypto capital gains?
Whether you have a gain or loss on the disposal of a digital asset depends on the value of the asset at the time of disposal measured against the cost basis of that asset.
Cost basis is the original purchase or acquisition price of an asset. If you purchase 1 bitcoin for $20,000, that is your cost basis which is then used to calculate any capital gain or loss from disposing of it thereafter. Tracking the cost basis across the broader crypto-economy can be difficult, as assets can be transferred across different wallets and exchanges.
7. How do I report crypto on my taxes?
You can use Form 8949 to report the Sales and Other Dispositions of Capital Assets. On Form 8949, a taxpayer details the number of units acquired, their dates of acquisition and disposal, cost basis, and any capital gain or loss.
8. How do I track crypto for tax purposes?
The simple answer is to keep records of your crypto transactions. The IRS is accelerating enforcement of crypto tax reporting as virtual currencies grow in popularity. That means you need to keep track of your crypto activity and report this information to the IRS in the appropriate tax forms.
TaxBit’s crypto tax software can help you track all of these transactions.
9. Can I write off my crypto losses?
The IRS allows investors to claim deductions on cryptocurrency losses that can lessen their tax liability or potentially result in a tax refund. Crypto losses must be reported on Form 8949; you can use the losses to offset your capital gains or deduct up to $3,000 a year from your ordinary income (referred to as the allowable capital loss deduction).
When offsetting your capital gains with losses, pay attention to the holding period of the assets in the red. You’re only allowed to offset long-term capital losses against long-term capital gains and short-term capital losses against short-term capital gains.
Once you have offset losses of the same type, your short-term losses are used first against your allowable capital loss deduction of $3,000. If, after using your short-term losses, you have not reached the limit on the capital loss deduction, use your long-term losses until you reach the limit. Any remainder above $3,000 will be carried forward into the next year, retaining its long- or short-term character.
10. If I bought crypto (like NFTs) with another crypto, is it a taxable event?
When you use cryptocurrency to buy an NFT, the IRS considers it a taxable event.
Purchasing an NFT is recognized by the IRS as disposal of a cryptocurrency, which means you’ll incur a capital gain or loss on the transaction and be taxed accordingly. The value of the crypto you used to purchase the NFT will determine your cost basis in that transaction.
For example, if you bought an NFT with cryptocurrency that has increased in value, you’ll have to pay taxes on the amount of the capital gain. If you held the cryptocurrency you used to buy the NFT for over a year, you’ll be subject to a long-term capital gains tax rate. If you held that crypto for less than a year, you’ll be faced with a short-term capital gains tax rate.
*Disclosure: This is not tax advice. Lolli cannot and does not provide tax advice. If you have questions regarding filing your taxes, please contact a registered CPA.