One of the most confusing things for new blockchain investors is knowing when you actually owe taxes on your cryptocurrency and NFTs. Some people even mistakenly believe that you don’t need to pay taxes on cryptocurrency at all. This is certainly not the case, and if you’re a little lost as to when and how much you’ll need to pay come tax season, here’s a short primer on cryptocurrency and your tax burden.
When do you owe taxes on cryptocurrency?
What really matters here is something called a taxable event. This is an event that the IRS views as you acquiring new income, and they will expect you to pay taxes on that income. When does this occur for cryptocurrencies or NFTs, though?
There are a couple of different scenarios to consider, and you can start by asking yourself how you acquired your digital assets, in addition to how and when you sold them.
You have sold an asset that you had previously purchased
The most common taxable event for investors comes from selling an asset. Anytime you sell a coin, token, or other assets for any reason you will owe taxes on your gains. This is why it’s important to keep records of when you purchased your assets and for what price. If you do not, then the IRS can assume a zero dollar cost basis and may want you to pay taxes on the entire value of the asset and not just your profits.
Knowing when you purchased your coins or tokens is also important because depending on how long you’ve had them, you may pay a higher or lower tax percentage on them. Cryptocurrencies are taxed as capital gains, and if you’ve held your assets for more than a year, you’ll enjoy a reduced tax rate on them.
Conversely, if you sell an asset you’ve held for less than a year, it will be taxed as regular income. That means if you sell a large percentage of your holdings, you could end up paying quite a bit more in crypto taxes than if you’d waited the full year before selling.
You acquired new assets through mining, staking, payments, airdrops, etc.
Have you acquired new tokens in a way other than buying them? This could include activities such as mining Ethereum on an AntMiner or through NiceHash, accepting cryptocurrency for goods or services, staking on a blockchain network, or earning interest on a Defi platform.
When new assets are minted or transferred into your wallet, they are instantly a taxable event. Since you have newly acquired this coin, token, or asset, it is seen as income, just like when you earn a paycheck at your day job. You’ll be taxed on the full value of that asset at the time of acquisition.
This applies to any way that you acquire new cryptocurrency or blockchain assets as well. It doesn’t matter whether they were mined, earned as interest, minted through staking, or even given to you as a free airdrop; they are still taxable in the eyes of Uncle Sam.
In addition, when you finally do sell these assets, you’ll also owe capital gains tax on them if they have further increased in value since you acquired them. Keep that in mind before you rush off to sell them, as careful planning can save you a bundle in taxes.
However, simply moving coins, tokens, or NFTs around to other wallets you own does not trigger a taxable event. You will only incur taxes in this scenario if the assets are new to you.
You have traded one cryptocurrency for another
Another popular myth in the cryptocurrency space is that a like-kind exchange of cryptocurrencies does not trigger a taxable event. This is also false. Trading Ethereum for Bitcoin, for example, is still considered taxable because you have sold the Ethereum to buy Bitcoin. You now would owe taxes on whatever gains you had made on your original Ethereum investment.
You have purchased goods or services with your cryptocurrency
Technically, if you purchase something from a store using cryptocurrency, or if you even trade cryptocurrency for goods, you owe taxes on your gains. As far as the government is concerned, you’ve still cashed out that investment and they want their cut if you made a profit.
While the IRS pursuing you over capital gains tax for your cup of coffee is unlikely, a large purchase such as a car may not go unnoticed, so buyer beware.
Will I owe taxes on cryptocurrencies I am holding?
If you are holding cryptocurrencies you’ve purchased without selling them or trading them for another asset, then no. You will not incur any taxes until you sell, as this is when a taxable event takes place.
How are NFTs taxed?
The United States government has not yet taken a stance on NFTs in regards to taxes. In most cases, you will pay the same capital gains tax rates as on other cryptocurrency assets. However, it seems likely that the government eventually will classify NFTs as collectibles.
Collectibles are also taxed as capital gains but with some added rules. The extended tax bracket for high-income earners goes up to 28% if NFTs end up being classified this way.