The federal tax rate on cryptocurrency capital gains ranges from 0% to 37%. Your specific tax rate primarily depends on three factors:
1 / The accounting method used for calculating gains.
2/ How long you held the coins before selling (Holding period).
3/ Your overall annual income (including non-crypto sources such as W-2) and tax filing status.
Knowing how these factors work can help you estimate your tax rate and set aside money to pay taxes at year-end.
The accounting method dictates which specific coin you are selling for tax purposes. Normally, coins are purchased at different times at different prices. The cost basis of the specific coin you are selling has a huge impact on the resulting profits subject to taxes (Profits = sales price – cost basis). Higher the cost basis, the lower the capital gains subject to taxes, vice versa.
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According to the IRS, you can specifically identify the coins you are selling as long as you have detailed records (A40). Selling the coins with the highest cost basis (Highest-in-First-out (HIFO) accounting) results in the least amount of gains subject to taxes. If you don’t have detailed records, the accounting method defaults to First-in-First-out (FIFO), where you are deemed to be selling the earliest purchased unit regardless of the price. (What Crypto Taxpayers Need To Know About FIFO, LIFO, HIFO & Specific ID)
For example, Jennet purchased two bitcoins (BTC) at $5,000 and $30,000 in 2016 and 2020, respectively. She sold 1 BTC for $50,000 during December 2020. Under the HIFO accounting method, she will have a $20,000 ($50,000 – $30,000) capital gain.
(If Jennet were to pick FIFO, she would have a higher capital gain of $45,000 ($50,000 – $5,000))
Holding Period & Filing Status
Once you figure out your gains under a preferred accounting method, those gains are then classified as either short-term or long-term capital gains depending on how long you held the coin before selling.
Short-term gains occur when you sell a coin after holding it for less than 12 months. Short-term gains are added to your regular income and subject to your ordinary income tax bracket.
Continuing with the example above, in addition to the $20,000 gain coming from crypto, Jennet also earned $50,000 from her full-time job during 2020. Jennet is a single filer. Note that her $20,000 of crypto gains is considered short-term capital gains because she sold the coin purchased during 2020, as opposed to the other coin purchased in 2016. In this scenario, Jennet’s total taxable income will be $70,000 ($50,000 + $20,000). Following the chart below, Jennet’s income will be subject to the 22% marginal tax bracket.
In additional to short-term trading profits, cryptocurrency interest income, staking income, mining income, airdrops and hard forks are taxed as ordinary income subject to following rates.
Long-term gains occur when you sell a coin after holding it for more 12 months. Long-term gains are subject to either 0%, 15% or 20% tax brackets.
Say Jennet sold the coin she purchased in 2016 instead of selling the coin she purchased in 2020. In this case, the capital gain of $45,000 ($50,000 – $5,000) is considered long-term. This amount will be subject to 15% tax rate.
Also note that if you have losses coming from other cryptocurrencies and stocks, you can use them to offset capital gains subject to some limitations set by the IRS.
As you can see there are multiple factors in play when determining your tax rate on cryptocurrency gains. The exact tax rate on cryptocurrency gains could also be affected by other credits, exemptions and deductions which could lower your overall taxable income. Complexities aside, you can clearly reduce your crypto tax bill by selling long-term coins with the highest cost basis.
Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.