For most, computing crypto taxes is no small matter and can be quite a tangled web, given the complexities and rapid changes in regulations.

But relax. This article will explain everything you need to know about computing your crypto tax, making the process much easier and more manageable.

Why is Crypto Tax Important?

With cryptocurrency trading and transactions mushrooming, one should consider the tax implications in most states worldwide. Whether buying, selling, earning, or spending crypto, the government expects a report on gains and losses. 

Further, since crypto regulations are more harshly implemented than traditional market regulations, we have seen that failure to comply would result in penalties or even an audit and, if the worse comes to worst, legal consequences.

Cryptocurrency is typically viewed as property or an asset by tax authorities like the IRS. Therefore, it is more or less equivalent to the stocks, bonds, and real estate you keep in your portfolio. Because of this, the gains and losses incurred through liquidating your cryptos must be calculated every time you trade, spend, or cash it out into fiat money.

What’s Taxable?

But to get your crypto tax, you must first identify which kind of cryptocurrency activities would bring tax liabilities. There are many types of taxable transactions, including:

Selling Crypto: This is the most common taxable component and requires very little explanation. Also, most of the crypto taxes applied are under this.

Trading One Cryptocurrency for Another: This is the same as above but operates within the crypto markets. Not knowing this, most people still think they would evade taxes if they were not reported as fiat transactions.

Spending Your Crypto: Most people don’t seem to understand that spending your crypto directly is also taxable. In such cases, the value increase in crypto from the date you purchased until you paid the crypto will be charged as capital gain tax.

Earning Cryptocurrency: As for any earnings that you make through cryptocurrency—whether it’s from mining, staking, airdrop, or you get paid for any goods and services, so long as you acquired it, then it has become your ordinary income. As a result, you have to report it as part of your income for the year.

Gifts and Donations: While cryptocurrency is not considered income in most territories and, therefore, not subject to taxation as a gift, giving above the thresholds of tax-free cryptocurrency may indeed be subject to gift tax for the donor. Furthermore, in many areas, gifting cryptocurrency to any charity is deductible at tax time.

How to Calculate Your Crypto Tax?

Now that we have covered the basics, let’s drill down and calculate your crypto tax.

1. Track Every Transaction:

Your first step in calculating your crypto taxes will be to keep a perfect record of every cryptocurrency transaction. This should include the date and time of every transaction, its type, such as buy or sell, trade, etc., the value of the cryptocurrency in fiat currency at the time of a transaction, and some fees associated with a transaction.

Most crypto exchange platforms provide you with transaction history reports that you can use for tracking. However, using specialized crypto tax software may make tracking much easier (such as automatically importing your trades from many exchanges and wallets).

2. Cost Basis

The cost basis is the cryptocurrency’s original value or purchase price, as well as all the transaction fees. To calculate your capital gains or losses, you must first determine the cost basis of the crypto you acquired.

Let’s assume you bought 1 Bitcoin for $30,000. Now, your cost basis for that Bitcoin is $30,000, and you sold that Bitcoin later for $40,000. So now, your capital gain is $10,000.

3. Capital Gains/Losses Calculation

A capital gain or loss occurs whenever a cryptocurrency is sold or bought in any exchange, P2P, or via ramps. No matter how you buy or sell, your profits from buying and selling crypto are taxed under short and long-term capital gains.

Assets could be taxed differently depending on how long you hold them. For that reason, tax authorities tend to categorize gains into two types of acquisition.

Short-Term Capital Gains: These are associated with the sale or trade of a cryptocurrency held for less than one year. In all probability, they are taxed in the hands of the owner at the ordinary income tax rate, which often proves to be greater than long-term rates.

Long-Term Capital Gains: Provided you held your cryptocurrency for over one year preceding the sale or trade. Any such gain is considered long-term capital gain, and the tax rate on long-term capital gains can be much lower.

4. Include Income from Cryptocurrency

If you mined or staked cryptocurrency or acquired income in the form of crypto, you will need to calculate and report the fair market value of the crypto at the time you received it as income.

For Example:

For example, if you mined 0.1 Bitcoin in such a time when it was worth $5,000, then the $5,000 has to be reported as taxable income, and then the sale or trade of the 0.1 Bitcoin would bring with it its sale value that would need to have calculations of capital gains or losses based on the value of Bitcoin at the time of its sale.

5. Transaction Fees Have To Be Taken Into Account.

Transaction fees in cryptocurrencies mean fees charged to process a cryptocurrency transaction; Gas on Ethereum, while network fees are the fees the Bitcoin network charges to process transactions. 

If you could use such fees to adjust your basis, it could help reduce your capital gains and corresponding tax liability.

Ways To Reduce Your Crypto Tax

Now that you know the number of your tax, you can do a few things that can help lower your liability;

1. Offset Gains with Losses (Tax-Loss Harvesting)

You can use realized losses on some crypto investments to offset your gains and reduce the taxes you need to pay. This is known as tax-loss harvesting in tax parlance, thus reducing the overall tax burden by realizing losses on failing investments before the end of the tax year.

2. Long-Term Holding

Because long-term capital gains are taxed at a lower rate than short-term gains, holding your cryptocurrency for over one year will significantly decrease the amount of tax you pay on profits.

3. Use Specific Identification for Sales

Many tax agencies permit you to use a Specific Identification method, enabling you to select which cryptocurrency units you sell or trade. This can be helpful when you want to sell the crypto units with the highest cost basis, which will reduce your gains.

4. Crypto-Friendly Jurisdictions

If you are a high-net-worth individual or even just an active trader, it is worth moving to a more crypto-tax-friendly country (or, in some cases, no tax at all on crypto). Leaders in this regard include Portugal, Switzerland, and Singapore.

Conclusion

Calculating the crypto tax is clear and less intimidating when you are appropriately armed with knowledge of the rules and track all your transactions. 

When all these transactions are tracked, it will be easy to understand your gains and losses and changes in the scope of regulation. Therefore, you will be assured of being compliant at tax time without nasty surprises. 

From casual investor to full-time trader, organization and being proactive about your crypto taxes lie at the heart of the matter.