If you own cryptocurrency, like bitcoin or ethereum, you need to understand how it impacts your tax liability every time you buy, sell or earn it.

What Is Cryptocurrency?

A cryptocurrency is a decentralized, digital store of value and medium of exchange. It’s not a currency with any physical tokens, like dollar bills, and it lacks any centralized governmental oversight.

Instead, cryptocurrency relies on encrypted, distributed ledgers—so-called blockchain technology—to record and verify all transactions. Think of blockchain ledgers as a constantly updated checkbook that tracks every transaction ever made in a given cryptocurrency.

Bitcoin was the first cryptocurrency, launched in 2009. Today there are thousands of others in circulation, including bitcoin cash, litecoin, ripple and dogecoin.

How Is Cryptocurrency Taxed?

Crypto taxes are generally based on a 2014 IRS ruling that determined cryptocurrency should be treated as a capital asset, like stocks or bonds, rather than as currency, like dollars or euros. This decision has had major ramifications for people who own crypto, as it has opened them up to more complicated taxes.

The IRS may have chosen to tax crypto as a capital asset because of the way most people treat it, says Jeff Hoopes, an associate professor of accounting at the University of North Carolina and research director of the UNC Tax Center. “I assume [the IRS] decided this because most people hold crypto as an investment, and we tax the appreciation on capital assets held as an investment,” he says.

Capital assets are taxed whenever they are sold at a gain. If you hold your cryptocurrency for more than one year and sell it for more than you paid for it, you will incur capital gains taxes. If you hold it for one year or less and realize a gain, you’ll pay ordinary income taxes, which are taxed at higher rates than capital gains.

Let’s say you bought $20 worth of bitcoin and have held it for three years, as your investment rose in value to $200. If you decide to sell it, you’ll owe capital gains taxes on your gain of $180.

But if you bought $100 worth of bitcoin and it decreased in value over three years, to $20, you’d be selling at a capital loss. Though you’re not required to pay any taxes on capital losses, you could use the loss to offset other income up to $3,000 ($1,500 if married filing separately), to reduce your taxable income. You’d have the option of claiming a portion of the loss each year until you’ve exhausted the total amount.

If you received cryptocurrency as a form of wages, your employer will report it at fair market value on your W-2, “Wage and Tax Statement.” You’ll need to report the amount on your income tax return and pay ordinary income taxes on the amount received.

Capital Gains Tax Rates vs. Ordinary Income Tax Rates

Here’s the good thing about crypto and taxes: If you’re required to pay capital gain taxes, the tax rate will be smaller than your ordinary income tax rate.

For the 2023 tax year, the capital gains tax rates are 0%, 15%, and 20%. Capital gains tax rates apply if you sell your cryptocurrency after holding it beyond one year and get more than you paid for it.

However, if you sell your cryptocurrency at a gain but have held it for only a year or less, you’ll be taxed at your ordinary income tax rate, which is determined by your income and filing status. For 2023, ordinary tax rates could be as high as 37%.

How Much Do I Owe in Crypto Taxes?

Whether you sell or earn cryptocurrency will determine how much you’ll owe in taxes.

When you sell crypto and have realized a gain on your investment, you may owe either normal income taxes or capital gains taxes, depending on how long you held the crypto. If you held it for a year or less, you’ll pay the higher, ordinary tax rates.

If you earn cryptocurrency by mining it, or receive it through a promotion or as payment for goods or services, it counts as regular taxable income taxed at your normal income tax rate.

In addition, if you hold on to cryptocurrency from these activities and either spend or sell it later for more than the value when you first received it, you’ll owe short- or long-term capital gains taxes on the profits, based on how long you held the crypto.

Do I Owe Taxes on Cryptocurrency?

Here are some questions to help determine whether you owe taxes on your cryptocurrency.

• Did you mine cryptocurrency? “Mining” crypto is when you use computers to solve complicated equations and record data on the blockchain. In exchange for this work, you may receive payment in new crypto tokens. You owe taxes on the fair market value of cryptocurrency you obtain by mining.
• Did you get crypto as a reward or an airdrop? If you receive cryptocurrency through a marketing promotion or an airdrop, it counts as taxable income.
• Did you receive payment for goods or services in cryptocurrency? If someone pays you crypto for goods or services rendered, the entire payment counts as taxable income, just as if they paid you in cash. Unlike a cash payment, though, your customer might also owe income taxes if their crypto provides them with greater value than they paid for it.
• Did you sell cryptocurrency to realize an investment gain? If you sell crypto for more than you paid for it, you owe tax on the gain as you would with stocks or mutual funds.
• Did you convert or exchange one crypto for another? When you convert or exchange crypto—swapping bitcoin for ethereum, for example—you owe taxes on any gains made in the transaction. If you purchased $400 worth of bitcoin and used it to buy $1,000 worth of ethereum, you’d owe taxes on $600 in realized profit, even though you’re just exchanging one crypto for another.

While this might seem like a lot to track, don’t take any shortcuts with your cryptocurrency taxes. You should even consider hiring a tax professional.

“Taxpayers are required to report their crypto transactions on their tax returns,” says Jon Feldhammer, tax partner at Baker Botts. “The IRS is cracking down on this.”