In November 2021, Bitcoin (BTC -3.08%) climbed to a record high of more than $68,000.
But 2022 has been a bumpy ride for the leading cryptocurrency. The price of a token dropped below $18,000 in late June, and its extreme volatility has left investors struggling to predict which direction Bitcoin will go in next.
There's still a chance for Bitcoin to get its groove back in 2022. But if the price surges and you're holding it, you may be on the hook for taxes. Below, we'll dive into how Bitcoin gains are taxed, and different scenarios you should be aware of before tax time.
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How taxes on crypto gains work
Bitcoin is the top cryptocurrency by market capitalization -- roughly $378 billion as of this writing, with tokens changing hands at a price of around $20,000.
If you were one of those who bought the dip and the price of Bitcoin shoots up before the end of the year, you might be tempted to lock in your gains by selling. But before you hit the sell button, you should consult with your accountant or tax advisor. They will give you a better idea of how to report those crypto sales to the IRS, if needed.
Cryptocurrency is classified as property in the eyes of the IRS, so you'll have to pay taxes on transactions with it that you make at a profit, just as you would with any other property transactions. Selling Bitcoin for more than you purchased it for in a taxable investment account can trigger capital gains taxes. So if you make money on your Bitcoin holdings, you should be aware of the crypto tax rate that applies to you before you splurge with those profits.
Breaking down short-term vs. long-term capital gains
Let's say you bought $60,000 worth of Bitcoin in July 2021 (when it was trading in the neighborhood of $30,000 a token). Now let's imagine that by November 2022, the price has rebounded and the value of your Bitcoin holdings has risen to $100,000. If you decide to sell at that point, you would have a $40,000 capital gain. Because you held onto your Bitcoin for more than a year before selling, you would be taxed at your long-term capital gains rate. Depending on your income, that rate will either be 0%, 15%, or 20% -- favorable levels.
If you sell assets -- including cryptocurrencies -- before you've held them for longer than a full year, however, the short-term capital gains rates apply, so get ready for a higher tax bill. Those marginal tax rates range from 10% to 37% -- the same rates that apply to the income you earn from working a job.
What if I don't sell my Bitcoin?
If you don't sell or trade your Bitcoin for a profit, you probably won't have to worry about capital gains taxes. You don't officially book a taxable gain or loss if you hold on to your Bitcoin.
If you only buy Bitcoin this year, you also won't trigger a taxable event. Taxes only come up when you sell, trade, or dispose of Bitcoin for a gain.
Crypto taxes apply to taxable investment accounts
Capital gains taxes apply when you make money in a taxable investment account. So if you hold your Bitcoin in a taxable investment account on a platform like Coinbase (NASDAQ:COIN) or Robinhood (NASDAQ:HOOD), you'll have to pay taxes on any profits you earn.
Be on the lookout for a Form 1099 from your exchange or broker to help you file your crypto taxes. The information it supplies will help you complete IRS crypto tax Form 8949. Again, if you get stuck and don't know how to report crypto gains on your taxes, you should reach out to your accountant or tax advisor.
But not all profits are taxed in the same ways. If you buy Bitcoin in your self-directed IRA (individual retirement account), sell it at a profit, and keep the proceeds in that account, then capital gains taxes won't apply. Capital gains taxes don't apply to retirement accounts.
Gains can trigger taxes
Anytime you sell or trade cryptocurrency for a profit in a taxable investment account, you trigger a taxable event. If Bitcoin surges at the end of 2022, you'll want to think twice before selling. Although the profits may look sweet in your account, you'll have to report your gains to the IRS.
Taxes on crypto are based in part on how long you've held your investment before disposing of it. If you're looking to maximize your gains, it's best to hang on to your Bitcoin for over a year before selling. The long-term capital gains rates will make all the profits in your portfolio more attractive.
