cryptocurrency individual tax

Individual Taxes and Cryptocurrency: What You Need to Know

The world of cryptocurrency seems to increasingly dominate headlines, and more than ever, we’re seeing individual investors including cryptocurrency within their wealth portfolios. If you hold cryptocurrency or may do so in the future, it’s critical to understand how your tax situation may be impacted and what your tax obligations are.

What Is Cryptocurrency?

Cryptocurrency is an online currency that an individual can exchange for goods and services. Unlike fiat currency, cryptocurrency is decentralized and not managed by a central authority. While cryptocurrency can be used for transactional purposes, many individuals have opted in recent years to hold it as an asset within their portfolio.

Tax Treatment of Cryptocurrency

For federal income tax purposes, cryptocurrency is treated as a capital asset, rather than a form of currency. Thus, an individual would pay taxes on cryptocurrency as they would any other gain realized from the sale or exchange of a capital asset (e.g. property, stocks, bonds, etc.). Relevant activity for cryptocurrency might include trading, selling cryptocurrency for cash, or using it as a form of payment.

The IRS designated cryptocurrency as property back in 2014 (see more below), but 2020 marked the first year that individual tax return forms required disclosure of any involvement in a cryptocurrency transaction with the following question: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

Capital Gains vs. Capital Losses

Because cryptocurrency qualifies for capital gains treatment, investors will be subject to short-term or long-term capital gains tax rates, depending on the length of holding time.

  • Short-term capital gains tax rate: If cryptocurrency was held for less than one year before disposal, the profits or gains earned will be subject to a short-term capital gains tax rate. This rate is the same as the individual’s ordinary income tax rate. Also, it is important to note that any income earned from mining, staking, airdrops or getting paid in cryptocurrency is subject to the ordinary tax income rate as well.
  • Long-term capital gains tax rate: If cryptocurrency was held for more than one year before disposal, the profits or gains earned will be separate from ordinary income and subject to a long-term capital gains tax rate. Depending on an individual’s income and filing status, the long-term capital gains tax rate is 0%, 15% or 20%.

Losses endured from cryptocurrency disposal must be reported as well. When disposing of cryptocurrency at a capital loss, the loss is eligible to offset capital gains or to claim the loss deduction. Individuals are eligible to deduct up to $3,000 in capital losses each year against ordinary income. Excess losses may be carried over and claimed on a future tax return.

Tax Deduction When Donating Cryptocurrency

If the cryptocurrency is held for more than one year before the time of a donation to a qualified charitable organization, the donor could be eligible for an itemized charitable deduction based on the fair market value of the cryptocurrency at the time of donation.

When donating cryptocurrency that is held for less than one year, the deduction will be limited to the amount at which the cryptocurrency was obtained, i.e. the donor’s cost basis.

MFA Observations
If you are interested in learning more about the tax treatment of cryptocurrency or how it could impact your financial situation, please don’t hesitate to connect with a member of MFA’s Tax Team.

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