- Short-Term Capital Gains and Losses. When you buy and sell an asset within a 365-day period, you recognize either a short-term capital gain if it sold for more than what you paid for it or a short-term capital loss if it sold for less than what you paid for it. Short-term gains and losses are subject to the same tax rates you pay on ordinary income, such as wages, salaries, commissions, and other earned income. The IRS has seven tax brackets for ordinary income ranging from 10% to 37% in 2021.
- Long-Term Capital Gains and Losses. If you buy an asset and sell it after one year, the resulting difference between your net sales proceeds and your cost basis is a long-term capital gain or loss. Typically, you’ll pay less tax on a long-term gain than on a short-term gain because the rates are generally lower. Currently, there are three tax rates for long-term capital gains – 0%, 15%, and 20%. The rate you pay depends on your income.
You can also offset capital gains with capital losses. However, the offset must first apply to gains and losses of the same type. For example, short-term losses first lower your short-term gains, while long-term losses reduce your long-term gains. Any remaining net losses can be used to offset the other kind of capital gain (e.g., remaining short-term losses can offset remaining long-term capital gains). If you still have any capital losses available, they can be used to offset up to $3,000 of ordinary income. After that, any remaining capital loss is rolled over to the following year.
Other Ways to Obtain Cryptocurrency
There are other ways to obtain virtual currency beyond simply buying it. For instance, you can earn cryptocurrency by mining it. You can also receive it as a promotion for goods or services, for free from cryptocurrency platforms, or for staking cryptocurrency. This latter activity allows you to earn interest by purchasing and setting aside your tokens to become an active validating node for a crypto network. In these situations, you owe tax on the entire value of the crypto on the day received and it counts as ordinary income.
See more: How do taxes work on crypto
Using Cryptocurrency to Pay for Goods and Services
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A complicating factor for crypto investors arises when they attempt to use their virtual currency to pay for goods and services. The IRS chose to treat cryptocurrency as property in 2014 because most people only saw it as a capital asset at the time. Now, as more companies choose to accept cryptocurrency as a form of payment and people begin to adopt it as a unit of account, many people have begun to see it as a viable alternative currency. However, the current tax treatment of crypto impedes the wholesale replacement of fiat currency.
With traditional fiat currencies, you simply pay for your purchase and have no tax consequences related to cost basis or the value of your currency at the time of payment. However, cryptocurrency users must deal with capital gains and losses in addition to whatever sales taxes they might face at the point of sale.
For example, let’s imagine you bought $10 worth of Bitcoin two years ago and it has since appreciated to $100 in value. If you sold it on an exchange, you’d have $90 of realized long-term capital gains, just like you would with any other capital asset.
If you instead used that same $100 worth of Bitcoin to buy groceries from the supermarket, you’d still have to pay long-term capital gains taxes on the $90 difference between appreciated value and your cost basis.
As you can imagine, tracking your capital gains and losses for everyday transactions like this can become tedious and a downright impediment to replacing fiat currency altogether.
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