What are cryptocurrency taxes 2020 and 2021? – Forbes advisor

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Do you own cryptocurrency? Perhaps you bought Bitcoin years ago when it was $ 100 and decided to take big profits in 2020. Or maybe you joined the revolution late and bought some Ethereum just to flip it over and sell it for a quick buck. Either way, you can owe taxes on your 2020 crypto transactions and you need to understand how this will affect your tax bill.

How do cryptocurrency taxes work?

For better or for worse, the capital gains tax rules apply to cryptocurrencies like Bitcoin and Ethereum. The Internal Revenue Service (IRS) treats all cryptocurrencies as investments and tax them when they are sold for a profit.

This means that when you purchase goods or services with cryptocurrency, you owe capital gains taxes if the cryptos you issued have increased in value than you originally paid for them.

Here’s an example: if you bought $ 10,000 worth of bitcoin in early 2019 and held it through the end of 2020, it would be worth roughly $ 40,000. Let’s say you used the full amount to buy a Tesla Model 3. You owe capital gains taxes on the $ 30,000 profit you made transferring that amount of Bitcoin to Tesla. You can just believe that issued Your Bitcoin – but for tax reasons, you sold Your Bitcoin with profit to Tesla (in exchange for a car).

If your crypto investment lost value in the meantime and you sold it for dollars, exchanged it for another cryptocurrency, or used it to buy a car, you saw a loss of capital. And you don’t owe any capital loss taxes. In fact, you can use capital losses to offset other income taxes.

Your cryptocurrency taxes depend on how long you hold crypto

Your cryptocurrency tax bill will depend on how long you’ve held it and your total annual income.

  • Short term capital gains. If you hold Bitcoin or Ethereum for a year or less, all gains are considered short-term capital gains, which are taxed at your regular income tax rate.
  • Long-term capital gains. Cryptocurrency gains held for a year or more are taxed as long-term capital gains, generally at a lower rate than most income taxes, depending on your annual income.

When you earn cryptocurrency by mining it or receiving it as a promotion or payment for goods or services, it counts as part of your regular taxable income. You owe tax on the entire value of the crypto on the day you received it at your regular income tax rate.

And if you hold the same cryptocurrency that you mined or earned through these activities, its value increases and you either spend it or later sell it for a profit, you would also owe capital gains taxes on the profits depending on how long you held it .

How to submit your 2020 crypto taxes

If there was ever a time to get organized with your crypto taxes, it is now: The very first question on the new 2020 Tax Return Form 1040 is whether you’ve made virtual currency transactions during the year.

If you answered yes to this question, here are some things to keep in mind:

1. Keep a record of all transactions

You need to keep track of all of your cryptocurrency transactions, including how much you paid for crypto, how long you held it and how much you sold it, as well as the receipts for each transaction.

Maybe easier said than done. “Some taxpayers trade cryptocurrencies a thousand times a year – or even more.

This can create unique accounting challenges and it can be extremely difficult to properly file a tax return, ”says Jon Feldhammer, tax partner at Baker Botts.

If you trade crypto on an exchange or investment platform, it can help you with bookkeeping and provide all the data you need to file your crypto taxes yourself or with the help of a professional.

2. Use software to track your crypto transactions

If your investment platform or exchange isn’t tracking your cryptocurrency transactions, or you conduct transactions in any other way, options are yours.

“Software companies have emerged that clean up the blockchain to detect transfers between your wallets, whether on an exchange or not, and give you reports on all transactions related to the wallets that you make within a given tax year,” says Field hammer.

Tools like Koinly and Cointracker connect to exchanges and crypto wallets to track your crypto transactions and fill out the forms you need to file your cryptocurrency taxes.

3. Fill out the correct tax forms

Once you have a record of your crypto transactions, you will need to fill out certain tax forms depending on how you have used your cryptocurrency:

  • Form 8949. This form logs every purchase or sale of crypto as an investment. This should include the total number of coins, the day and price you bought, the day and price you sold, and your profit or loss for each transaction.
  • Planned. This form summarizes your total capital gains and losses from all investments, including crypto.
  • Schedule C. If you have received coins from mining, you must state whether you received them for work or as a hobby. If you were running a crypto mining business, you would report this income in Appendix C and subtract your expenses. However, your expenses may have to be very high to offset the extra self-employment tax you would incur if you viewed your mining as a business rather than a hobby.
  • Annex 1. If you were reporting your crypto mining as a hobby, you would include that income on line 8 of Appendix 1. You don’t owe self-employment tax, but you become more limited on what to deduct as expenses.

4. Report your taxes

If you keep records in software like Koinly or CoinTracker, you can connect them to your favorite online tax software. Then use the online tax software to file all of your state and federal tax returns. For those looking for a one-stop shop, TokenTax offers a full range of accounting services to help track and prepare both your crypto and regular taxes.

5. Hire a professional

Preparing for cryptocurrency taxes can be complicated, especially as the laws that surround them are constantly evolving. If you’ve made significant income from cryptocurrencies, it may be worth hiring a professional accountant who specializes in this type of tax work so that you don’t get persecuted by the IRS later.

How to minimize crypto taxes

If you think you will owe taxes on cryptocurrencies in the future, there are six ways you can minimize them:

1. Hold cryptocurrency for the long term

If you hold a crypto investment for at least a year before selling it, your profits will qualify for the preferred long-term capital gains rate. Depending on how much money you make a year, this can cut your tax rate almost in half, from a maximum of 37% for short-term gains to a maximum of just 20% for long-term gains.

2. Balancing profits with losses

As with any investment, you can take advantage of crypto profits by claiming losses from other investments in the year you realize your profit. That said, if you made $ 10,000 selling Bitcoin but lost $ 10,000 selling Ethereum, you wouldn’t owe any taxes because you hit breakeven.

However, these losses are not limited to other forms of cryptocurrency. When you’re about to cash in on a large crypto investment, look at the rest of your portfolio to see if there are other losing investments that you could sell to offset your gains. And if you end up losing significantly more than you gain in a year, you can deduct up to $ 3,000 in excess losses from your personal income tax, as well as carry forward unused losses to offset your future investment gains.

3. Time sales with your tax rate

If you have the luxury of time on your side, you can always try and wait for a lower tax rate, says Jeff Hoopes, associate professor at the University of North Carolina and director of research at the UNC Tax Center.

“Maybe you got fired, retired, went back to school, or moved to a more tax-efficient state. Then you may find yourself in a lower tax bracket that allows you to sell your cryptocurrency while owing less tax, ”he says.

4. Claim mining costs

While it may seem like an inexpensive activity in theory, mining crypto comes with significant costs, including computers, servers, electricity, and internet service provider fees. If you are a crypto miner, you can deduct these costs from your mining income, although the amount you can deduct depends on whether you categorize your operation as a business or a hobby.

5. Consider investing through an annuity plan

Investing in crypto with an annuity plan like a traditional IRA or Roth IRA allows you to defer or avoid investment gains entirely, although it is not as easy as investing through a regular brokerage account.

“There are ways to get crypto into tax-deferred vehicles like an individual retirement account (IRA), but it’s not as common and not as easy (although many expect it to be easier),” says Hoopes. Now, if you want to open a crypto or bitcoin IRA, you need to open a special account called a self-managed IRA with boutique firms that offer crypto investments.

6. Donate to charity

If you don’t need all of the profit from your crypto investment, you can reduce your tax burden by donating at least some of your crypto to charity. You will receive a deduction equal to the full value of your crypto, including any winnings. However, this usually only makes sense if you have already planned a charitable donation.

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