But since it is so new, and we are still only becoming aware of it, it can be unclear how to handle your crypto investments safely. As with any budding system, the ground rules are still forming, and it’s easy to get caught on the wrong side of the law. This can make dealing with the new kid in town a little scary.
All is not as daunting as it seems, though. Today, I have put together a guide on what you should do to avoid legal trouble when investing in crypto markets.
Paying taxes on your cryptocurrency
Only two things in life are guaranteed – death and taxes. While cryptocurrencies may be virtual and therefore immortal, they are not exempt from the latter.
So how do you pay taxes on something that technically doesn’t exist?
Well, first and foremost, you must remember that the IRS has defined the likes of Bitcoin as a property, not currency. Further, crypto’s status as a decentralized currency means the specifics of which tax rules it falls under are hazy.
If you are gifted Bitcoin or any other cryptocurrency, neither you nor the donor pays any income tax. Taxes only come into play when you use or receive cryptocurrency as part of a trade. Let’s take a look at what this means:
- If you get paid in crypto as a form of income, it falls under your ordinary income tax rate. This could be as payment for work or as currency for the sale of goods.
- If you acquire any form of cryptocurrency by mining or staking, it is also taxed at your income tax rate.
- If you make money selling your cryptocurrency, then it is subject to capital gains tax. This means you will be taxed on the amount of money you make in profit from the sale. Generally, this splits into two categories: short- and long-term capital gains.
- If you sell the currency in less than a year after buying it, it is subject to short-term capital gains. In other words, you’ll pay a tax that’s equivalent to your normal income tax.
- If you held it for over a year, then it becomes subject to long term capital gains, which stands at:
- 0% for up to $40,000 (single income)
- 15% between $40,001 and $441,450 (single income)
- 20% for $441,451 and above (single income)
- (Married and Head of Household rates can be found here)
Conversely, if you make a loss on any disposed of cryptocurrency, you can use it to offset your capital gains up to $3,000.
For example, if you were to sell two Ethereum, one at a profit of $50,000 and the other at a loss of $2,000, you can subtract that $2,000 loss from your profit. Instead of paying 15% tax on $50,000, you would only pay it on $48,000.
Remember: It’s important to keep rigorous documents of your sales and purchases. Make a note of the date and time of each transaction, the exact value of each currency at those times, and the differences between their values.
The legal standing of cryptocurrencies
Cryptocurrency’s status as a digital entity means it has no physical presence. This means no centralized issuing authority backs it, making it somewhat complicated to invest in and trade. That’s why it pays to learn about the legal standing of cryptocurrencies and how they affect your wealth.
Firstly, cryptocurrencies are accountable to the jurisdictional laws of each state. This can make it difficult to determine what laws a transaction falls under. Since both parties may be in different states, their laws may not work well together. This is one more reason you should ALWAYS DOCUMENT EVERY TRANSACTION in detail.
You will often hear people talk about how cryptocurrencies can be used as a form of money laundering. Its very nature helps create anonymity amongst users, allowing money to exchange hands from illegal to legal sources without being traced. However, this is much harder to do than you’d think.
For converting virtual currencies into physical cash, you must conduct a sale transaction. This transaction will be subject to anti-money-laundering rules, making it easy to catch any attempts to circumvent legitimate taxable income. This ties back into the advice I gave earlier about keeping track of your transactions. As long as you keep detailed documents, you will always be able to prove the legitimacy of your earnings.
Further tips on keeping out of trouble
I know trading in cryptocurrencies can be a baffling experience, but if done right, it is well worth it. Not everything has to be as overly complicated as trawling through tax from the small text. Follow these tips to make things a little easier:
- Frequently check the IRS guides to virtual currencies – Since the rules and laws around cryptocurrencies are always evolving, your best offense is a good defense. If you check the IRS guidelines, you will always be ready for each change as they come.
- Seek Professional Help – There are people out there who devote themselves to the study of cryptocurrency. They can advise you about best practices and golden opportunities, and also keep you from making costly mistakes. Find yourself a cryptocurrency coach, so you always have someone to advise you when things get confusing.
- Make gifts and donations in crypto – If you send your crypto as a gift to your relatives, it counts as a non-taxable event. Any gifts up to $15,000 in value can help you save on your capital gains tax.
- Remember to take your deductions – Just because it hurts to take a loss doesn’t mean it has to be a loss. Your loss can also be your gain when it comes to claiming against your deductions.
Cryptocurrency is new and uncharted but new rules are rising up to define acceptable practices. The murky is becoming clearer! Take the above into consideration, seek help, and avoid legal troubles while making a little extra cash. It always pays to be a pioneer in a new land, so don’t hesitate to take that first step—just take it with care.