Everyone is talking about cryptocurrency these days, and it’s easy to see why. After all, the value of Bitcoin (BTC) temporarily surpassed the $60,000 threshold earlier this year, and Ethereum (ETH) has quadrupled in value since the beginning of 2021. Of course, there are other cryptocurrencies currently making waves and helping at least some people rake in the cash, which continues creating hype among investors and everyone else.
But, there’s one aspect of crypto investing that hardly anyone is talking about — the tax implications. This is partly because taxes are boring in general, but it’s also because a lot of crypto investors have no idea what they’re doing. And — for the record — the same problem is going to come into play this year regarding NFTs, or non-fungible tokens.
How Is Cryptocurrency Taxed Anyway?
Tax partner Jon D. Feldhammer of Baker Botts says that, generally speaking, cryptocurrency is treated as property and taxed accordingly. This means that you’ll face tax implications when you sell your crypto or NFT or you trade either one for another investment or even a purchase.
Let’s say you buy 1 Bitcoin (BTC) for $30,000 on January 1, 2021, and then sell it on May 6, 2021 for $50,000. In that case, Feldhammer says you would have $20,000 of taxable short-term gains.
However, he says things get tricky from here, because it’s common for people to make frequent trades for various purposes. For example, let’s say someone has $50,000 in BTC and they want to buy an NFT. In that case, they might need Ethereum to buy a specific NFT, so they trade BTC for ETH to make the purchase. In this case, Feldhammer says you still face $20,000 of taxable income because you exchanged the property (BTC) for other property (ETH), which is a taxable transaction.
Also consider this scenario: You bought BTC for $5,000 at some point in 2020, and your investment has now grown to over $50,000 in value. Law partner Asher Rubinstein at Gallet Dreyer & Berkey says that, if you decide to use your BTC to pay for a new Tesla
You might like to think of it as a swap, he says, but “it’s like buying $5,000 worth of stock and selling it for $50,000.”
Short-Term Vs. Long-Term Capital Gains
Another factor to be aware of is the fact that, for many crypto and NFT traders, frequent transactions are the norm. For example, there are a slew of investors who constantly “buy the dip” on the favorite cryptocurrency then sell when prices are high only to do it all over again.
Aaron Sherman, who is President of Odyssey Group Wealth Advisors, says many newbie investors may not realize how gains are taxed when you don’t keep crypto for very long. If the asset was held for at least one full year, the gain will be taxed at a long-term capital gain rate, which is lower than ordinary income tax rates, he says. Meanwhile, if the asset was held for less than a year, the gain is taxed as a short-term capital gain, with a rate equal to the investor’s ordinary income tax rate.
“The difference between short-term and long-term tax treatment is meant to encourage investors to hold assets for longer periods,” says Sherman. “Because of this difference, those who are day trading crypto assets could face a large tax bill on any gains they may have.”
In the meantime, Feldhammer points out that NFTs may be considered a “collectible,” in which case they would be subject to a top tax rate of 28%, rather than 20%.
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