Tax filing for cryptocurrency investors in 2022- Recent Cointracker Survey Says Many are Still Confused
If you invested in crypto last year, you may be in for a surprise this tax season.
Yes, your Bitcoin, Ethereum, and other cryptocurrencies are taxable. The IRS considers cryptocurrency holdings to be “property” for tax purposes, which means your virtual currency is taxed in the same way as any other assets you own, like stocks or gold. 2021 was a big year for crypto, with many new investors buying in for the first time. More than half of current Bitcoin investors began investing in the last 12 months, according to a recent study by Grayscale Investments. The crypto market hit multiple all-time highs and lows throughout the year, leading to large gains and losses for many investors.
Tax returns (or extensions) are due on Monday, April 18th, but cryptocurrency investors will likely be pushing that deadline to the very end. New data was released by a recent CoinTracker.io survey that shows that 96% of cryptocurrency investors had not filed their tax returns as of March 27, 2022. Americans overall, in contrast, have filed roughly 40% of the individual returns expected to be filed in 2022.
What has changed? Confusion about how to file crypto and NFT taxes. The average CoinTracker user, for example, has crypto transactions in three exchanges or wallets, and 3 out of 4 have added more than one exchange or wallet in the last 12 months. Using multiple exchanges and wallets increases tax complexity for crypto investors.
There are a number of software solutions such as Cointracker or TokenTax that allows you to seamlessly track your entire crypto portfolio across exchanges and wallets, helping you monitor market value, investment performance, transactions, and taxes as you transact with cryptocurrency.
Cointracker noted that in partnership with Wakefield Research they commissioned a nationwide survey of U.S. cryptocurrency investors which found that given a list of possible cryptocurrency situations that require paying income tax, just 3 percent got all answers correct, leaving 97 percent with at least one wrong answer. For example, a majority don’t realize they need to pay taxes when trading one type of cryptocurrency for another or when using cryptocurrency to buy a good or service.
According to the article in Cointracker, surveys like this underscore the importance of ongoing education so that crypto users can file taxes more accurately and seamlessly, and save time and money. If you need to get up to speed quickly on how to file your crypto taxes, there are plenty of helpful resources such as this guide to filing your crypto and NFT taxes and the rundown of which three tax forms you’re going to need to fill out.
For most retail investors who buy and trade crypto within online exchanges, accounting for it in your tax return is relatively easy. But like most things related to digital currency, things can get a lot more complicated the more active you are.
Here’s what you need to know about which activity you might need to report to the IRS, and how you can begin planning ahead for your 2021 taxes.
When to Report Cryptocurrency Trades on Your Tax Return
Purchasing Crypto With Dollars
Simply buying virtual currency with U.S. dollars and keeping it within the exchange where you made the purchase or transferring it to your personal wallet does not mean you’ll owe taxes on it at the end of the year.
If your only crypto-related activity this year was purchasing a virtual currency with U.S. dollars, you don’t have to report that to the IRS, based on guidance listed on your Form 1040 tax return.
Things start becoming taxable when you use crypto as a method of exchange. This includes selling your crypto for U.S. dollars, exchanging one cryptocurrency for another — buying Ethereum with Bitcoin, for example — or paying for goods and services with crypto.
Daniel Johnson, a financial advisor and founder of RE|Focus Financial Planning told Time Magazine “whenever you sell the investment or exchange the investment for another investment, that is when a taxable transaction happens,” She also stated “you’ve got to be careful if you’re doing a lot of trading. If you’re going in and out of different types of cryptocurrency, every single time you place that trade, it is a taxable event.”
Trading or Minting NFTs
A non-fungible token, or NFT, is a token created on a blockchain that proves you are the only owner of that one-of-a-kind digital item, whether it’s a digital sports collectible or an animated flying cat with a Pop-Tart body. You can buy and sell NFTs in digital marketplaces like OpenSea and SuperRare.
And like crypto, they are taxed.
But because the IRS has not released any specific tax guidance on NFTs, it can be a little confusing to navigate. According to Shehan Chandrasekera, CPA and head of tax strategy at CoinTracker.io, a crypto tax software company, the specific tax implications of a given NFT depend on two things:
- whether you’re an NFT creator or investor
- and to what extent you’re interacting with NFTs (i.e. as a hobby or a business).
If you’re creating or minting, NFTs, it’s important to know what events are taxable and how they’re taxed. For example, paying gas fees to mint an NFT is a taxable event. Say you make NFTs for fun and spend 0.1 Ethereum to mint an NFT. If you originally purchased this Ethereum for $100, and it’s worth $300 at the time you minted the NFT, then the transaction would generate a $200 capital gain for you. You would be subject to either a long-term or short-term capital gains tax rate, depending on how long you held the Ethereum before using it to mint the NFT. However, if you were a professional creator who frequently minted NFTs for your business, the $100 would be treated as ordinary income. Mr. Chandrasekera also told Time, “if you’re a hobbyist, you report income but you cannot deduct any business-related expenses, but if you’re creating NFTs as a business, then you can deduct business-related expenses.”
Once you sell that NFT for crypto or exchange it for another NFT, that triggers another taxable event. It would be taxed as income since you’re earning (or losing) money for selling the NFT you created. Any royalties you earn for an NFT you created would also be taxed as income.
For NFT investors, taxes work similarly to the way they work for crypto trading. Most art-based NFTs are classified as collectibles for tax purposes, which subjects them to capital gain taxes like other common cryptocurrencies. Any time you purchase an NFT using a cryptocurrency like Ethereum or sell an NFT, you’ll be subject to capital gain taxes. The amount you’ll owe will depend on how long you held the NFT and whether you made a profit. You can also claim losses on NFTs in your taxes, according to Chandrasekera.
When Will You Owe Taxes on Cryptocurrency
Because the IRS considers virtual currencies property, their taxable value is based on capital gains or losses — basically, how much value your holdings gained or lost in a given period.
When you trade cryptocurrencies or when you spend cryptocurrency to buy something, those transactions are subject to capital gains taxes, because you’re spending a capital asset to get something or get another asset.
The difference between the amount you spent when you bought or received the crypto (its cost basis) and the amount you earn for its sale is the capital gain or capital loss — what you’ll report on your tax return. Broadly speaking, if you bought $100 worth of Bitcoin and sold it for $500, you’d see a capital gain of $400. If your Bitcoin lost value in that time, you’d instead face a capital loss. If your losses exceed your gains, you can deduct up to $3,000 from your taxable income (for individual filers).
The amount of time you owned the crypto plays a part, too. If you held onto a unit of Bitcoin for more than a year, it would generally qualify as a long-term capital gain. But if you bought and sold it within a year, it’s a short-term gain. These differences can affect which tax rate is applied. The tax rate also varies based on your overall taxable income, and there are limits to how much you may deduct in capital losses if your crypto asset loses value.
Short-term capital gains are taxed as ordinary income, according to 2022 federal income tax brackets.
You can use Form 8949 to reconcile your capital gains and losses, and then report them on your Form 1040 tax return using Schedule D. If you’re an NFT investor or hobbyist, you can use the same form to report NFT minting gains or losses and NFT trades. Just make sure to enter code “C” in column (f) to show that you sold an NFT, which is treated as a collectible. The IRS’s website has additional information and tools to help you determine your crypto-related tax liability and how to report it on its website.
If you’re just dipping your toes into trading Bitcoin or another cryptocurrency, and only have a few transactions (with accurate cost basis reporting), you may be able to easily report your crypto earnings yourself using your typical tax software.
Mr. Chandrasekera stated that “most people are pretty simple: they have a W-2, they have a couple of 1099 interest forms, and they may have some crypto.” He went on to explain that “so those people don’t really need a CPA. But if you’re somebody dealing with large amounts of money, you’re making DeFi transactions, staking or mining operations, those people will want to have a CPA to sit down and do tax planning and tax-saving strategies.”