The IRS treats cryptocurrency as property, not money, and taxes it like a stock. Taxpayers must disclose gains and losses on investments in digital assets. Profits on assets held for more than a year are taxed at the long-term capital gains rate, now a top 23.8%, which includes the Affordable Care Act levy. However, crypto received as payment for goods or services, used to pay someone else, or swapped for another currency is treated as ordinary income and taxed at ordinary rates, now a top 37%.
Figuring out profits and losses on crypto hinges on knowing what you paid initially or your cost basis. That determination can be a nightmare for digital assets that have moved between exchanges and wallets or been airdropped as free currency into your wallet. It’s even more tangled if foreign or decentralized exchanges or “forks” (the computer code underlying a coin splits into two) are involved.
Most exchanges send a 1099-MISC for miscellaneous income when an investor has more than $600 in transactions. This form typically discloses only interest income and money earned from referring customers to the exchange and from staking, not capital gains or losses. Staking is when an investor uses his crypto stake to vouch for the accuracy of other transactions on the exchange.
Some exchanges send a 1099-B detailing cost basis, gross proceeds, as well as capital gains and losses. Investors might also receive a 1099-K, which shows the volume of all transactions with a given exchange, regardless of whether they’re taxable. Details are not provided on gains and losses.
Exchanges and payment networks such as Venmo were supposed to start issuing 1099s to customers who have at least $600 in cash or crypto transactions starting on January 1, 2023. However, the IRS announced on December 23 that it is pushing back the lowering of the reporting threshold. Instead, the IRS will treat 2022 as a transition year. Companies are required to report calendar year 2022 transactions at the previous threshold of $20,000 and more than 200 transactions.
The wash-sale rule doesn’t apply to cryptocurrencies because the IRS doesn’t consider them “securities.”
This rule requires a person to wait 30 days before or after selling a stock at a loss before repurchasing the same share or one “substantially identical.” Some investors can sell their losing crypto, buy it back immediately when it rebounds, and use the loss to offset profits on other investments. The strategy is basically tax-loss harvesting — a staple with exchange-traded funds — that’s not subject to the wash-sale rule.
If the losses exceed the profits cashed in on other investments, an investor can use what’s left to reduce up to $3,000 of ordinary income a year and roll remaining amounts forward to lower taxes in the future. With short-term capital gains on assets held for less than a year, equal to ordinary rates, an investor in a high-tax state like California can avert a roughly 50% federal and state tax bill on a crypto sale, according to CoinDesk.
Sal’s Insights: Taxpayers need to be familiar with the rules regarding the tax treatment of cryptocurrency. Now is the time to explore potential tax elections which could help reduce your tax obligation on digital assets.
Taxpayers are currently required to self-report income from digital assets on their federal return by answering the question: “At any time during 2022, did you: (a) receive (as a reward, award, or compensation); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?” Taxpayers must truthfully answer this question to avoid issues in the future. As reporting requirements on digital assets become more involved, it is in your best interest to work with an exchange that provides detailed information on each digital transaction, including the price paid and your cost basis. Moving forward, this information will become critical.