Crypto Apr 15, 2021

The Nexus Between Cryptocurrencies and Taxation

The world has been watching the crypto realm keenly, even as Bitcoin and other virtual assets continue to grow in value. Bitcoin, specifically, has been registering record highs amid widespread support.

Apart from law enforcement agencies, the Internal Revenue Service (IRS) has been hard at work trying to regulate the crypto industry. Today, for all persons holding or planning to own cryptocurrencies, the subject of tax liability is critical – whether you intend to buy, sell or mine it.

The idea of crypto taxes began with a 2014 IRS decision that ruled cryptocurrency should be considered a capital asset, just like traditional stocks and bonds, as opposed to fiat currencies. The decision brought about major changes in the crypto industry, and ushered in a host of implications for people in the context of complex tax laws.

Do You Owe Taxes on Crypto?

Essentially, capital assets must be taxed at the point where an individual sells it at a profit. When you buy goods or services with virtual currency, and the amount of digital coin you spend has grown in value compared to the initial investment, spending it will attract capital gains taxes.

Using a hypothetical example: if you bought Bitcoin worth $50 and stored it until it gained value to become $200, spending the crypto to purchase $200 worth of goods will attract capital gains taxes on the $150 profit you made. This rule holds true against the reality that you seemingly spent the Bitcoin, rather than sold it.

The practice of crypto mining, where an individual employs computers to solve complex equations and enter data on the crypto ledger system, is also subject to the IRS requirements. When you mine crypto and receive payment in the form of new tokens, you owe taxes on the whole value of cryptocurrency gained through mining.

In addition, apart from being taxed for receiving cryptocurrency via a marketing promotion exercise, all activities involving the receipt of payments in form of cryptocurrency qualifies for taxation – the government calls this “taxable income”.

Further, in case you convert or exchange one cryptocurrency for another, such as swapping Bitcoin for Ethereum, you’ll owe taxes on all gains made through such a transaction. This holds true to such engagements despite the fact that you were just exchanging one form of digital asset with the next.

Why Crypto Is Taxed

According to an explanation provided by Jeff Hoopes, associate professor at the University of Carolina and research director of the UNC Tax Center, the IRS decision to tax cryptocurrency as a capital asset is pegged on how its holders treat it – people hold virtual assets as a form of investment.

Quite obviously, we can all understand why the IRS decided to join the crypto party considering that the virtual asset industry had begun raking in tens of millions of dollars each day in trading volumes. Bitcoin and the other crypto assets presented a very attractive tax revenue source to the taxman.

Nonetheless, the subject of crypto taxation must be understood from the lens of capital gains vs. capital losses. A digital currency holder only owes taxes whenever they spend or sell and end up earning a profit. In cases where a user spends or sells cryptocurrency at a loss, they are exempted from taxation as far as the relevant transaction is concerned.

For instance, if an individual purchased $20,000 worth of Bitcoin and sold it for $25,000, their taxable gain becomes $5,000. But if the same person sold the same amount of crypto for $10, 000, they’d owe nothing in taxes. In fact, they could even use a portion of the $10,000 in Bitcoin losses to counter other investment gains.


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