Do You Have to Pay Taxes on a Crypto Wallet?

Crypto popularity has skyrocketed in the last couple of years, thanks to the global acceptance and adoption of crypto.

In fact, stats indicate that approximately 16% of adults in the US have traded or owned cryptocurrency, and the global crypto market has reached over $3 trillion in value. This shows the high potential of cryptocurrencies.

Digital assets come with exciting opportunities, but also challenges, such as tax compliance.

Because of this, many countries around the globe are clamping down on regulation. In the US, the IRS treats crypto as property. This makes a lot of crypto transactions taxable.

In this article, we will learn about taxable and non-taxable crypto events when using an ai integrated smart crypto wallet. We will also cover the calculation of tax obligations, strategies to minimize liabilities and record-keeping requirements.

Taxable Crypto Events

Here are scenarios that typically trigger tax obligations:

1. Selling Cryptocurrency for Fiat Currency

Selling cryptocurrency in exchange for traditional currencies such as USD, EUR, or GBP is a taxable event. It is treated as a disposition of property by the IRS, and they require you to report any capital gains or losses.

So, if you bought Bitcoin at $20,000 and sold it for $25,000, the $5k profit is subject to tax. Furthermore, gains are categorized as either short-term (crypto held for less than a year) or long-term (held for over a year), with different tax rates applied depending on the holding period.

2. Trading Cryptocurrency

Swapping other cryptocurrencies—for example, swapping Bitcoin for Ethereum—is also a taxable event. For every trade, the IRS would require you to calculate its fair market value at the time of the trade. Your gain or loss is determined by comparing this value with the cost basis of the crypto you traded with your decentralized crypto wallet.

That is, if you sell your Bitcoin for Ethereum ($10k of Bitcoin for $12k of Ethereum), even though it was a currency-to-currency transaction and not a market currency versus a fiat currency (like the history of currencies were based on prior to the last 50 years or so) the $2,000 gain is taxable.

3. Using Cryptocurrency to Pay for Goods and Services

When you use cryptocurrency to pay for goods or services, it is considered a disposal event. That means even the tiniest of purchases, such as a cup of coffee, need to be reported when the price paid using crypto has gone up in value since you bought it.

So, for instance, if you paid for a service with $500 worth of Bitcoin, and the Bitcoin is worth $700 when applied to the purchase, that $200 gain will be taxed. Because these transactions are often reported by vendors, having accurate records is paramount to compliance.

4. Earning Cryptocurrency

Any crypto income, such as employment, freelance work, or contract services, is considered ordinary income and is, therefore, taxable. Its taxable amount is based on the fair market value of the crypto when it is received.

So, say you receive 0.1 Bitcoin for performing a service, and at the time you received that payment it was worth $3,500 — that means your income is $3,500. This means that when the IRS taxes, there is a calculation on any future gains or losses, when you sell/trade this crypto for any currency.

5. Mining Rewards

Cryptocurrency earned through mining activities is considered taxable income. The fair market value of the mined coins on the day they are received determines their taxable value.

Besides income tax, mining operations may also incur self-employment tax if conducted as a business. For larger mining setups, expenses like electricity and hardware costs may be deductible, but thorough documentation is essential.

6. Staking Rewards

Cryptocurrency rewards earned through staking—participating in blockchain validation processes—are taxed the same as mining rewards. You will need to declare the receiving staking reward as income at its fair market value when received. Any future profits or losses realized on the reward are taxed when the staked crypto is sold.

7. Hard Forks and Airdrops

Hard forks and airdrops result in receiving new cryptocurrency, which is considered taxable income when the coins become available for use.

So, for example, if you receive 1 ETC worth $25 at the time of the hard fork, it means that your taxable income is valued at $25.

Airdrops handed out as promotional rewards are taxable at their fair market value when you receive them, whether or not you have requested them.

8. Crypto Loans and Collateral Liquidation

When you pledge crypto to secure a loan, if your collateral is liquidated as the result of a margin call — triggered when the value of your collateral falls below the required maintenance margin level — and sold at some point, that sale is a taxable event. Interest earned on crypto in some type of lending platform, similarly, is taxed as income recognized at the fair market price when it was received.

9. NFT Transactions

Non-fungible tokens (NFTs) are subject to taxation in several ways. Selling an NFT for crypto incurs capital gains tax, while earning royalties from NFTs is taxed as ordinary income. The creation and sale of NFTs may also involve self-employment tax if done as part of a business.

Non-Taxable Crypto Events

Here are some things that are not taxed:

1. Buying a fiat currency for crypto

You do not incur tax until you sell, trade, or spend crypto. Just buying or holding it is tax-free.

2. Moving From One Wallet To Another

Transferring crypto between your wallets does not incur taxes, given you stay the owner.

3. Gifting Cryptocurrency

Gifts up to the annual exclusion amount ($18,000 for 2024) will be tax-free. If the recipient sells the gift in the future, they take your cost basis.

4. Donating Cryptocurrency

Donations to qualifying charities may be tax-deductible based on the crypto’s fair market value at the time of donation.

Tax Calculation and Reporting

If you’re wondering: how much is crypto taxed? Here is how to compute and report crypto tax;

1. Capital Gains Tax

To calculate capital gains, you need to find the difference between the price at which cryptocurrency was sold (due to cashing or trading) and its cost basis. The cost basis is the price paid, including fees. So, let’s assume you purchased Bitcoin at $10,000 and, after a few weeks, sold it for $15,000 — if this is the case, your taxable gain would be $5,000 (USD).

As stated earlier, gains are classified as short-term (if it’s held for less than a year) or long-term (when held for over a year), with short-term gains taxed at regular income rates and long-term gains taxed at reduced rates (0%, 15%, or 20%).

2. Income Tax

Crypto earned due to mining, staking, or payment for services are treated as taxable income. You must report the fair market value of the cryptocurrency on the day it was received. For example, Suppose you offer freelance work and are paid in Ethereum worth $2,500 at the time of sale. In that case, that is ordinary income (and taxable to you). If the value of Ethereum changes before you sell it, any subsequent profit or loss is also taxed.

3. Cost Basis Methods

Accurate record-keeping is crucial when choosing a cost-basis method, as it determines your taxable gains or losses on your white label crypto wallet. Common methods include First In, First Out (FIFO), Last In, First Out (LIFO), and Highest In, First Out (HIFO). For example, under FIFO, the oldest crypto purchased is considered sold first. HIFO, on the other hand, calculates gains based on the most expensive crypto purchased. Selecting the right method can significantly impact your tax liability.

4. Transaction Records and Reporting Tools

Having a clear record for every transaction is necessary when reporting taxes. Note all details pertaining to every purchase and sale, including receipts, wallet addresses, transaction timestamps, and fair market value.

Tax software, crypto wallet tax calculator and tools like Koinly or CoinTracker can help automate calculations, prepare IRS-compliant tax reports and make the process easier. Failure to properly report crypto transactions can incur penalties or audits.

How to Reduce Crypto Taxes

Here are some strategies you can apply to reduce your tax liability while staying compliant with regulations:

1. Hold for the Long Term

Long-term cryptocurrency holdings are taxed at lower capital gains rates compared to short-term holdings.

Therefore, when you keep your crypto investments for over a year, you can benefit from reduced tax rates. This will help to lower your overall tax burden.

2. Tax-Loss Harvesting

Selling cryptocurrency at a loss can offset gains from other investments, reducing your taxable income.

Unlike traditional stocks, crypto transactions are not subject to the “wash sale rule.” This implies that you can repurchase the same asset immediately after selling at a loss. This strategy can be a powerful tool during market downturns.

3. Utilize Deductions

If you engage in crypto-related activities such as mining or trading as a business, you may be eligible to deduct expenses. These can include mining equipment, electricity costs, or even software used for tax preparation. Always consult with a tax professional to guarantee compliance.

4. Gift or Donate Crypto

Gifting cryptocurrency can help reduce your taxable estate. What’s more, donating crypto to a qualified charity can provide you with charitable deductions, potentially lowering your overall tax liability. Therefore, ensure the recipient or organization understands the value and proper handling of crypto assets.

5. Invest in Retirement Accounts

Some platforms now allow crypto investments within Individual Retirement Accounts (IRAs). So, if you make contributions to these accounts, you can defer taxes on your crypto gains. This offers a tax-efficient way to build wealth over time.

Record-Keeping Requirements

Accurate record-keeping is crucial for managing crypto taxes effectively. Maintain detailed records of all transactions, including:

• Purchase and sale receipts
• Transaction history from wallets and exchanges
• Cost basis and fair market value at the time of each transaction

The IRS can audit tax returns up to six years in the past, so ensure your records are complete and well-organized.

Consequences of Non-Compliance

Failure to report cryptocurrency income or gains can result in severe penalties, interest charges, and audits. The IRS actively monitors crypto transactions through exchanges and blockchain tracking tools. That’s why proper reporting is essential to avoid legal and financial repercussions.

Conclusion

Crypto tax obligations depend on your usage and the transactions performed on your wallet. However, being aware of taxable and non-taxable crypto events can help you plan ahead with tax-reduction strategies. This will help you stay compliant with the law while minimizing liability.

If you are unsure about crypto taxation, you can find tax professionals, or top-tier blockchain consultants, like Debut Infotech, to help walk you through the complex world of crypto taxation.

What’s more, Debut Infotech has an experienced team of tax specialists and blockchain developers to provide clear, actionable guidance suited explicitly for how you engage with cryptocurrency—avoiding pitfalls and maximizing efficiency. As a reputable cryptocurrency wallet development company, they have deep knowledge in more than just taxes, offering advanced blockchain development services to assist companies in leveraging the transformative potential of blockchain. Whether you’re an investor or an emerging company, you need a partner that delivers reliable and professional solutions in blockchain technology & crypto-compliance. Debut Infotech is all for it.