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Cryptocurrencies have been surging in popularity for over 15 years. There are a variety of avenues through which clients can secure blockchain wealth, and the means by which a digital asset enters your portfolio is just as important as the asset’s value.
Because the digital corner of finance is still relatively new, many clients are blindsided by how assets like Bitcoin and NFTs are reported on returns. Knowing how the IRS defines different assets is essential to digital investing and trading.
Key Takeaways
- Digital assets are most commonly classified as property, not income.
- When cryptocurrency is exchanged as payment for a service, or if you mine it personally, that value is reported as income.
- Long- and short-term capital gains rates apply to digital asset sales.
- Keeping investment assets separate from spending currency helps simplify tax reporting.
What I’m Telling My Clients
For the most part, cryptocurrencies behave the same way stocks do. A digital coin can be purchased as an investment, and the moment the investor cashes out and takes a profit, that’s a taxable event. You then owe capital gains tax on the value increase from when you bought to when you sold the asset.
Of course, people also use their digital assets like cash, which can muddy the waters. If you bought a certain coin as an investment, held it for a year, then used it as part of a trade or purchase, you still need to pay the capital gains tax on the difference in value.
Important
Most trading sites will log the buying price and date, but it’s the investor’s job to note that information with things like NFTs.
Here are a few of the things I remind my clients about when it comes time to file taxes:
- Holding assets over one year can reduce the capital gains tax by adjusting from the short-term to the long-term rate.
- For IRS definition purposes, any representation of value recorded on a blockchain or similar technology constitutes a digital asset.
- As much as possible, investors should keep digital investments separate from digital currency used for purchases and payments. This will help avoid confusion with paying taxes.
The Bottom Line
With crypto no longer a novel form of wealth but rather a common holding in people’s portfolios, it’s more important than ever to understand how taxes work on all types of digital assets. If you pay attention to what you have and how you use it, you’ll be able to avoid complications on your tax return.
