Capital gains tax: What is it and how it applies to your crypto
Are you ready for the 2021 tax season? Time to learn about U.S. capital gains taxes — and how they can impact your crypto.
How much will you owe?
If you bought cryptocurrency for the first time in 2021, congratulations — and welcome to the party. It’s been a banner year for crypto investments: more than half (55%!) of Bitcoin owners reportedly made their first purchases of the popular crypto last year. Crypto, while designed as an alternative to the traditional banking system, is still subject to U.S. tax laws as administered by the U.S. Internal Revenue Service (IRS). So if you made a profit from selling your crypto, trading it, or buying goods and services with it in the past year, it’s time to think about the tax you may pay on your capital gains.
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How much will you owe?
The federal capital gains tax — a tax on profits you make from selling certain types of assets — also applies to your crypto transactions. Rates range from 0% to 37%, with additional tax for those with higher incomes. How much you'll owe depends on a number of factors. (Note: to make things simple, we talk about crypto sales in the examples below, but capital gains taxes also apply to trading or converting crypto and spending it to buy goods and services.)
How long you held onto your crypto before selling it. The federal government taxes short-term gains and long-term gains differently, as we explain below.
Your annual income, including revenues from all sources, and your tax filing status.
How much money you gained or lost by selling your crypto. Your profit, for tax purposes, depends in part on the cost basis of the crypto you’re selling — the total amount you paid for it, including fees. To determine your profit, subtract the cost basis from the sales price: the higher the cost basis, the lower your profit. To arrive at this figure accurately, make sure to keep detailed records of all your crypto transactions.
The cost-basis method you use to calculate your gains. Using the highest-in-first-out cost-basis method (HIFO), you sell the crypto first that has the highest cost basis to keep your gains — and your taxes — as low as possible. Last-in-first-out (LIFO) accounting means you sell the crypto you bought most recently — this can be advantageous when values are increasing. But if you haven’t kept detailed records of your purchases, you won’t be able to demonstrate to the IRS which crypto you’re selling. In that case, the IRS requires you to use the first-in-first-out (FIFO) cost-basis method. This method assumes that the crypto you’re selling is the one you’ve held the longest.
Long-term gains, short-term gains, and tax rates
As noted above, your tax rate depends on several factors, including your overall income and whether you have short-term or long-term capital gains.
Short-term gains can happen when you sell or otherwise dispose of your crypto after holding it for less than one year. At tax time, you’ll fold these gains into your regular income, then pay taxes on everything together at your ordinary income tax rate. Note: Those with incomes above a certain threshold may also have to pay a separate tax called the Net Investment Income Tax (or NII).
Long-term gains generally happen when you sell or otherwise dispose of your crypto after holding it for longer than a year. These gains are taxed at rates of 0%, 15%, or 20% (plus the NII for higher incomes). The exact rate depends on a few factors, but it’s almost always lower than the rate you’d pay on short-term gains. Most people will pay no more than 15%, and you may pay zero if your annual taxable income is less than $80,000.
What if you lost money?
And what if you sell your crypto at a lower price than what you bought it for? As with other investments, if you sell your crypto at a loss — meaning it has fallen in value by the time you sell it, trade it, or spend it — you can claim a capital loss. Losses aren’t all bad — they can lower your tax bill overall by offsetting other income. So if you profit from one crypto transaction, but you lose money on others, you can use your losses to offset your gains, subject to limitations set by the IRS.
There are other ways to minimize your tax burden, too. Tax-loss harvesting, for example, involves intentionally selling some of your crypto at a loss to offset gains you’ve made on other sales. With this strategy, you can use your loss to offset the profit you’ve made on other crypto or stocks, reducing the amount of taxes you owe.
The bottom line: Being prepared helps you save on taxes
Planning ahead is the very best way to minimize your tax liability from capital gains on your crypto transactions. To recap:
Consider how long you’ve held your crypto before selling it.
Record all of your purchases, trades, and sales.
Choose the accounting method that best reduces your tax liability.
Watch the market for the best times to sell, especially if you’re hoping to use tax-loss harvesting to offset gains.
And make sure to consult your tax or financial advisor about these and other considerations regarding crypto investments. With crypto, as in life, a little planning goes a long way.
Trade crypto on Coinbase?
For more information on crypto and taxes as well as tools for tracking your crypto transactions, Coinbase users can sign in and check out Coinbase Taxes.