A Complete Breakdown on How Your Cryptocurrency Profits Are Taxed

It is well known that cryptocurrency operates decentrally with no central body governing it. However, that does not mean it is not taxed.

With its growing popularity, investors are also interested in the tax implications of this emerging asset class, especially when it comes to cryptocurrency profits.

The United States views cryptocurrency as property, whereby the Internal Revenue Service considers it a capital asset. Capital assets are significant assets like stock, art, or investment property, and the IRS requires individuals to report the type of capital gains or profits they have depending on the length of time they are held.

Because each taxable event may create a capital gain, investors need to know the date, cost basis, sale value, and any fees associated with each transaction.

While taxation on cryptocurrency is still in discussion, here's a list of possible situations that would incur a tax:

• Selling cryptocurrency: If sold and there is a capital gain realized, it will be subjected to tax based on one's income tax bracket.
• Exchanging cryptocurrency: If the exchange realizes a capital gain, this will trigger a tax.
• Paying for goods and/or services: Purchasing any good and/or service with cryptocurrency will trigger a tax.
• Gifting crypto to another person or charity: Often, gifting does not result in taxes, but depending on the lifetime gift-giving amount, as it relates to the taxable threshold, it may be taxable.

The cost to acquire an asset is known as one's basis. If the proceeds of a purchase exceed the cost to acquire, it is known as a capital gain. In contrast, if reversed, whereby the basis is more than the proceeds, this is known as a capital loss.

Short-term gains and losses are determined by the length of time an asset is held. Short-term gains and losses occur are when an asset is held within 365 days and is subjected to the same tax rates as ordinary income.

Ordinary income is salaries, commissions, and any other form of earned income. Tax payers' incomes are divided into seven brackets ranging from 10 to 37 percent.

For example, if an investor decides to purchase Ethereum at $3,500 and then in a couple of months as ETH price surges, the investor sells ETH for $5,000, there is a short-term capital gain of $1,500 that must be reported and taxed based on one's income.

In contrast to assets that realize short-term gains or losses, assets that realize long-term gains and losses are assets that are held for over a year. Assets held for the long term are subject to different tax rates, called capital gain rates than short-term holding.

There also may be additional long-term state taxes that are incurred depending on the investors' place of residence. In New York, for example, the long-term total rate can be as high as 31.5 percent (20 + 11.5 percent New York state rate), assuming the top income bracket.

However, taxpayers typically pay less for long-term capital gains since the rates are usually lower than those for short-term gains. According to the IRS, as of 2019, the rates ranged from 0 to 20 percent whereby it is determined based on the taxpayers' income and the tax bracket they are in.

Understanding cryptocurrency tax implications can help minimize the crypto taxes owed since some strategies are developed in relation to capital gains and losses.

When investing in cryptocurrency, it is important to record every transaction for reporting as they are required for accurate filing for tax season.