Here’s how the rules change for investors

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When you think of cryptocurrency, images of spurs, Stetson hats, and six-shooters may not come to mind. But when speaking to experts about regulators’ approach to digital currency, one phrase seems to pop up over and over again.

“It’s the Wild West right now,” says Zak Killermann, cryptocurrency editor for personal finance site Finder.com. “Regulators are still figuring this out, so it’s important that investors stay informed. Things can change very quickly.”

Very quickly, in fact. The Senate recently gave the green light for an overhaul of how crypto profits are reported, as part of the bipartisan $ 1,000 billion infrastructure bill. If passed as is, the bill could make it easier to calculate tax liability for some crypto investors, while emphasizing the importance of tax compliance for others.

Read on to find out how crypto is taxed now and what the impending changes could mean for your wallet.

Cryptocurrencies are taxed like stocks with one important exception

Bitcoin debuted in 2009 as a decentralized digital currency, which could function as an alternative to the existing global financial system. But it didn’t take long for investors to get involved, making large sums of money speculating on the value of bitcoin and other digital currencies.

In 2014, the IRS realized that digital currency wasn’t just used to make payments and released a new set of rules. “The IRS has said that if it’s something you can trade real dollars for and make a profit for, it’s property and not just currency,” said John Buhl, senior communications director for Urban -Brookings Tax Policy Center. “Because it’s an asset that you can buy, own, and sell, you have to pay capital gains tax. “

This means that crypto is primarily taxed like stocks, mutual funds, or ETFs. Sell ​​it for a profit after holding for less than a year, and the gains will be taxed at the short-term capital gains rate, equivalent to your income tax rate. Hang on for more than a year and you will benefit from a more advantageous tax rate: 0%, 15% or 20% depending on your income.

Video by Helen Zhao

As is the case with traditional investments, investors can sell cryptos at a loss to offset capital gains, a strategy known as tax-loss harvesting. If your losses exceed your gains in a given tax year, you pay no capital gains tax and can deduct up to $ 3,000 in losses from your regular income. Losses over $ 3,000 can be carried forward to future tax years.

There is one key area where the rules of crypto differ. Because cryptocurrency is taxed as property, it is not subject to the so-called “blank sale rule,” which discourages investors from buying “essentially identical” investments within 30 days. following the sale of a stock or fund for less than the price you paid to acquire it. If you do not follow this rule, you will not be able to claim this initial loss for tax purposes.

If you sell Apple shares at a loss, for example, you have to wait a month before buying the shares again to avoid a washout sale. If you sell an S&P 500 index fund, all funds that follow the index are prohibited, not just the one you own. But with crypto, “if you’ve suffered a loss, you can sell it and buy it back immediately,” says Killermann. “There is no expiration date for these losses. You can accumulate them and carry them all over indefinitely.”

Why keeping records of crypto transactions is important

Selling crypto for cash isn’t the only way to trigger a taxable event. If you own a popular cryptocurrency, using it to buy goods and services or exchanging it for other types of digital currencies will mean you will owe capital gains tax as well. Receiving free crypto as part of a marketing promotion, known as an airdrop, also counts as regular taxable income.

In order to profit from the harvest of tax losses, you’ll need to keep meticulous records of your crypto transactions, says Killermann. Otherwise, the IRS might not believe you. “You must enter with records of each transaction how, where and when you purchased it.”

“As much as it’s a property, because you can use it as currency, it makes it a lot more complicated to know how much you started with and how much you earned,” says Buhl. “There’s no central authority to follow this stuff. And for an investor, it’s a lot harder than saying, ‘I bought this and I sold that. “”

How the new legislation affects crypto investors

Even if you don’t try to take advantage of the wash sale loophole, it’s a big problem lawmakers hope to at least partially address with the new legislation. The law aims to make the reporting of cryptocurrency trading activity as transparent as with stocks, where information about the timing and profitability of your transactions is reported directly to the IRS by your brokerage.

Under the new rules, crypto brokers would be required to report investor transaction information to the IRS. Consternation persists over what the bill, which has yet to be passed by the House, defines as a “broker”, with critics fearing the law will force companies on the outskirts of the crypto brokerage ecosystem , such as minors and software developers, to report customer information that they do not have.

While major exchanges, such as Coinbase, are likely equipped to report your information to the IRS, the vast majority of crypto owners do not hold their coins on such platforms. In fact, at the start of July, only 13% of available bitcoin was held on exchanges, according to crypto data tracking site Santiment.

Video by Stephen Parkhurst

If you are one of the crypto investors who do not invest through an exchange, you may not be in the IRS spotlight right now. But that doesn’t mean you shouldn’t try to calculate and pay the tax you owe to the best of your ability, Buhl explains.

“You want to be in compliance. The government emphasizes that you owe them, and it’s up to individuals to decide whether to follow the law or leave it to chance that they won’t be audited,” he says. “People have made hundreds of thousands of dollars trading crypto. And as you will remember with Al Capone, if you have income that you don’t report it will trigger red flags and you can have big. problems.”

If calculating everything on your own seems expensive, services like CoinTracker and ZenLedger can track your crypto wallet and calculate your tax liability for you. For people who frequently transact in crypto, signing up for one of these services is a small price to pay for peace of mind, says Killermann.

“You have to weigh the cost-benefit ratio,” he says. “What’s a $ 100 subscription versus a giant fine you could possibly have to pay to the IRS?” “

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