Do I Have to Pay Taxes on Cryptocurrency and NFTs?

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by Advice Chaser
by Advice Chaser

Whenever you earn income, whether from a salary or from investments, you owe taxes to the IRS. But what about digital transactions? Do those count? And how can you properly report income and pay taxes on cryptocurrency and NFTs?

Recently, a legal change has caused ripples through crypto circles, as people wonder what it means and what it changes about their tax responsibility. But in reality, not much should change if you are already reporting your capital gains correctly. If not, it’s time to start, before you land in serious trouble.

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What Taxes You Owe on Cryptocurrency

You owe tax every time you sell an investment at a profit. So if you buy anything, from a stock to a house to an NFT, and later sell it for more than the purchase price, you have made a capital gain. As such, you owe capital gains tax on the amount you profited.

Sale Price – Purchase Price (Basis) = Capital Gain

When you sell at a loss, on the other hand, you can apply some of those losses to offset your gains. If you lose more than you make, you might not end up owing taxes on your investments at all.

Any time you buy, sell, or trade an investment, you create a taxable event. So imagine you bought Ethereum some time ago for $100, at a lower price than it’s currently worth. Then today you used your Ethereum to buy an NFT. The initial purchase is not taxed, but hopefully you made a record of what you spent. This is your basis for that investment, the initial purchase price.

When you paid that Ethereum for an NFT, however, this was a taxable event. The sale price was whatever that Ethereum is worth today. Say it’s now $1000 for the same amount. So you’ve profited $900, and must report this transaction as a capital gain. You should also record the purchase price of that NFT, so that when you sell it, you’ll know how much you earned or lost on the investment.

What Has Changed?

The recent infrastructure bill that just passed the legislature included a provision for cryptocurrency and NFTs, which may make it harder to evade taxes. To be clear, the taxes you owe on these transactions remain exactly the same. But more entities will need to report transactions to the IRS than before, so it becomes much more difficult to launder money this way.

If you’re already paying taxes as appropriate, you don’t need to worry too much. The law is intended to apply to “brokers,” which most of the bill’s writers meant to mean exchanges like CoinBase. However, it’s unclear enough that some worry it could be extended to miners and developers as well. It’s up to the Treasury Department to clarify this before the law goes into effect.

When an exchange reports your transactions to the IRS, it will also send a record to you, in the form of a 1099B. But, since the exchange might not know you what you paid for your investments, these documents might not be accurate. You’ll still need to keep your own records.

It’s also a blow to cryptocurrency privacy, because any transaction over $10,000 will need to be reported, including your name, address, and Social Security number. Many crypto users would prefer to remain anonymous.

How to Avoid Tax Errors

Thanks to the current boom in NFTs, some investors are making large amounts of money for the first time. That makes them unprepared to handle the tax implications. If you’ve made a tidy profit, strongly consider spending some of it on sound advice from a trusted financial advisor or accountant.

Keep Good Records

Every time you make a transaction in crypto or NFTs, keep a careful record of what you spent, both in crypto and in US dollars. The IRS considers cryptocurrency an investment, not a currency, so using crypto to buy anything (from other crypto to NFTs or other products) also counts as selling an investment. So does trading one NFT for another. You need to know what you actually paid for the product and how much it was worth when it left your possession. The difference between these two numbers is your capital gain or loss.

Know Your Tax Rate

Many of your crypto and NFT investments will be held for under a year. That means these transactions will be taxed as short-term capital gains, which are subject to the same tax rate as regular income. So you will pay whatever you would pay on your salary, up to 37% (the highest tax bracket). If you hold cryptocurrency for over a year, however, you can enjoy the lower long-term capital tax gains rate, which is only 20%. But NFTs, as collectibles, are subject to a tax of up to 28%, even if you hold them for years.

In addition, you may have to pay the Net Investment Income Tax (NIIT) if your total adjusted income is more than $200,000 ($250,000 for married couples). This is an additional 3.8% tax.

Pay Quarterly Taxes

If you will owe more than a thousand dollars at tax time, the IRS doesn’t want to wait for its money. You will have to pay one quarter of your estimated taxes for the year in each of these months: April, June, September, and January. You can do so on the IRS’s online portal, the Electronic Federal Tax Payment System.

Write Off Your Losses

If you have lost money on your investments, you can use some of these losses to offset your gains. But be aware that short-term losses must be used to offset short-term gains, and long-term losses for long-term gains.

Need Help Paying Taxes on Your Cryptocurrency Investments?

Any time you’re investing, it helps to get sound advice from a professional. That’s especially true when you invest in something both new and high-yield like cryptocurrency. There’s little trustworthy advice available online, and you might quickly make enough money to change your tax situation drastically. You need a financial advisor who knows how to navigate this novel and growing market. To get started, contact us so we can match you with the right professional.

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