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Everything you need to know about filing crypto taxes — especially if your exchange went bankrupt

Your crypto could be taxed as an asset or as income depending on your actions.

Sopa Images | Lightrocket | Getty Images

Cryptocurrency is classified as property by the IRS. That means crypto income and capital gains are taxable and crypto losses may be tax deductible.

Last year, many cryptocurrencies lost more than half their value and major crypto exchanges — like FTX — collapsed. The silver lining is you may be able to reduce your 2022 tax burden if you lost money in crypto.

CNBC Select talked with Shehan Chandrasekera, head of tax strategy at CoinTracker, a crypto tax software company, about how cryptocurrency is taxed and what you need to know if your crypto exchange declared bankruptcy.

How cryptocurrency is taxed

Many of cryptocurrency's most passionate advocates emphasize the decentralization of the blockchain, but it's important to remember that the federal government is keeping tabs on who is earning how much when it comes to crypto and taxes.

"The biggest misconception in this space in general is that people think that crypto is invisible to the regulators. But that's not the case," says Chandrasekera. There's a permanent record of all your activity on the blockchain and many crypto exchanges report to the IRS.

For the most part, the IRS treats crypto as an asset subject to its rules on capital gains and losses, similar to stocks. When you buy cryptocurrency or stocks, the original purchase price of the asset becomes its cost basis. When you sell that asset, you're taxed based on the difference between the cost basis and the sale price.

Capital gains and capital losses are based on the net total of all transactions that year. If you sold five different assets for a total gain of $10,000 and three other assets at a total loss of $15,000, then you have $5,000 in capital losses.

You can deduct up to $3,000 a year in capital losses from your taxable income and can carry over losses exceeding that annual limit to future years. For example, if you had $5,000 in capital losses in 2022, you can reduce your taxable income by $3,000 in 2022 and apply the remaining $2,000 in losses to 2023.

Capital gains are taxed differently based on how long you hold an asset before selling. Short-term capital gains taxes apply to assets you've held for one year or less and long-term capital gains taxes are assessed when you sell an asset after owning it for more than one year.

Your exact capital gains rate depends on several factors, but long-term capital gains are typically taxed at a lower rate than short-term gains. And you may not have to pay any capital gains tax at all, depending on your filing status and taxable income.

If you use digital currency for daily transactions, you may want to enlist the help of a tax professional. For everyone else, tax software offered by companies such as H&R Block, TurboTax, TaxSlayer can help you file your taxes when you have taxable-crypto transactions.

H&R Block

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In most cases, capital gains and losses apply to your crypto transactions. However, there are instances where cryptocurrency is taxed as income, in which case it's subject to a marginal tax rate of up to 37% depending on your income level and filing status.

Below we examine how each type of crypto transaction is classified for tax purposes:

1. Selling cryptocurrency (capital gains)

Anytime you sell cryptocurrency the gain or loss in value has tax implications. This type of transaction tends to be straightforward, especially if you aren't frequently buying and selling crypto, and is classified under capital gains.

2. Exchanging one cryptocurrency for another (capital gains)

A crypto swap is when you directly trade one cryptocurrency for another without exchanging your crypto for cash.

Chandrasekera points out that many people mistakenly overlook this type of transaction when it comes to taxes because no cash was realized. But if you exchange Bitcoin for Litecoin or Ethereum for Bitcoin, it's a taxable event.

3. Spending crypto for goods or services (capital gains)

Using crypto to buy goods or services has the same tax implications as selling it. "It could be as little as you're going to Starbucks and spending a fraction of a Bitcoin to buy something and that could result in a taxable gain," Chandrasekera says.

When you're buying anything with crypto, the taxable gain or loss is based on what you paid for the cryptocurrency and its value at the time of the transaction.

4. When you earn cryptocurrency (income)

When you earn cryptocurrency it is considered taxable income based on the value of the coins at the time of receipt. This includes crypto earned from activities such as:

  • Mining cryptocurrencies
  • Crypto staking income
  • Yields on crypto accounts
  • Crypto earned as regular pay or bonuses

5. Anytime you receive free coins (income)

There are instances where you may receive free crypto and the value of the digital coins you receive is considered income.

Two common scenarios where you may receive free crypto are airdrops and hard forks. An airdrop is when cryptocurrencies are given away for free and it's typically used as a marketing tool for new cryptocurrencies.

A hard fork is a bit more complicated but to simplify it, it's essentially when a cryptocurrency splits into two types of tokens or coins. When this happens, you'll have your original coin and a new coin, with a separate value. The value of the cryptocurrency you receive from a hard fork is taxable income.

What to do if your crypto exchange went bankrupt in 2022

Last year, a crash in the crypto markets led to a string of crypto firms declaring bankruptcy — most notably FTX, which at its peak was valued at $32 billion.

If you had crypto assets tied up in a company that's filed for bankruptcy, unfortunately, there isn't anything you can do for the 2022 tax year. "When those bankruptcies get finalized in 2023, we will have more clarity on the amount of loss, the type of deduction you can get depending on the findings of the bankruptcies," Chandrasekera says.

The bankruptcies could be the result of fraud or simply bad business decisions and, "all those things affect the amount of the deduction, the type of the deduction and even when you can take the deduction," Chandrasekera says. It's also possible that you may get (some of) your money back, he says.

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Bottom line

The IRS classifies cryptocurrency as property or a digital asset. Any time you sell or exchange crypto, it's a taxable event. This includes using crypto used to pay for goods or services.

In most cases, the IRS taxes cryptocurrencies as an asset and subjects them to long-term or short-term capital gains taxes. However, sometimes cryptocurrency is treated as income. Keep track of all your crypto activity so you don't get a nasty surprise at tax time.

Catch up on CNBC Select's in-depth coverage of personal financetech and toolswellness and more, and follow us on FacebookInstagram and Twitter to stay up to date.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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