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Hit the Bitcoin Jackpot? Don't Let Taxes Steal Your Joy

By Charlene Rhinehart, CPA - Mar 10, 2021 at 8:24AM

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Understanding how taxes work will make your Bitcoin profits even more rewarding.

Bitcoin (BTC 1.65%) provided explosive gains that have triggered more attention from the IRS. So, if you've made profits on selling Bitcoin, make sure you give the IRS a piece of the pie or you might be hit with a colossal tax bill later.

To avoid any surprises or headaches, here are a few tax items you should know if you've made money as a Bitcoin investor. 

Bitcoin gold coins flying everywhere.

Image source: Getty Images.

Earning quick profits on Bitcoin 

The meteoric rise of Bitcoin within the last year made it easy to earn profits. But if you were tempted to sell Bitcoin and grab your cash too soon -- within a year of buying it -- then you'll be on the hook for the highest tax rate category known to cryptocurrency investors. 

Here's why. According to the IRS, Bitcoin is considered property instead of currency. That means you'll be subject to the same capital gains tax rates that you would pay when you sell stocks. And selling anything within a year of when you bought it subjects you to higher short-term capital gains rates.

Let's say you bought Bitcoin for $13,000 and sold it at $20,000 three months later. You'll have a $7,000 short-term capital gain that is taxed at the ordinary income tax rates shown below.

2021 Ordinary Income Tax Rate For Single Taxpayers For Married Couples Filing Jointly For Married Couples Filing Separately For Heads of Households
10% Up to $9,950 Up to $19,900 Up to $9,950 Up to $14,200
12% $9,951 to $40,525 $19,901 to $81,050 $9,951 to $40,525 $14,201 to $54,200
22% $40,526 to $86,375 $81,051 to $172,750 $40,526 to $86,375 $54,201 to $86,350
24% $86,376 to $164,925 $172,751 to $329,850 $86,376 to $164,925 $86,351 to $164,900
32% $164,926 to $209,425 $329,851 to $418,850 $164,926 to $209,425 $164,901 to $209,400
35% $209,426 to $523,600 $418,851 to $628,300 $209,426 to $314,150 $209,401 to $523,600
37% $523,601 or more $628,301 or more $314,151 or more $523,601 or more

Data source: IRS.

Selling your Bitcoin after more than one year 

Patience pays off when it comes to cryptocurrency and taxes. If you sell your Bitcoin for a profit after a year of holding it, you'll unlock the favorable long-term capital gains tax rates. These rates can be as low as 0% depending on your income and filing status. 

It's important to keep track of when you bought your Bitcoin so that you can know when you've passed the one-year mark. As you can see from the long-term capital gains tax rates below, there's a big difference in your tax bill if you decide to sell your Bitcoin after a year. These tax rates apply even if you sold a fraction of your Bitcoin. 

2021 long-term capital gains tax brackets

For Single Filers With Taxable Income of...

For Married Joint Filers With Taxable Income of...

For Married Couples Filing Separately With Taxable Income of...

For Heads of Households With Taxable Income of...

...This Is the Long-Term Capital Gains Tax Rate

$0 to $40,400

$0 to $80,800

$0 to $40,400

$0 to $54,100

0%

$40,401 to $445,850

$80,801 to $501,600

$40,401 to $250,800

$54,101 to $473,750

15%

Over $445,850

Over $501,600

Over $250,800

Over $473,750

20%

Data source: IRS.

How to tackle taxes with ease

If you don't want to wait or lack faith in the cryptocurrency's ability to rise continuously, you can always sell and take advantage of tax-loss harvesting to reduce your tax bill.

Tax-loss harvesting is a strategy that allows you to offset short-and long-term gains of the same type and then use the excess to reduce other types of gains. Essentially, you can offset your cryptocurrency gains against any stock market losses in your portfolio to lower your taxes. 

Also, consider working with a professional if this is your first time reporting Bitcoin on your tax return. You'll want to make sure that you are in compliance with all tax requirements because the IRS is cracking the whip on cryptocurrency activity. 

Reporting and documentation are important. To avoid manual calculations and recordkeeping, consider obtaining tax software to automatically import Bitcoin data from exchanges. The software may also help you calculate your tax-loss harvesting benefits.

This is just a glance at how Bitcoin taxes work; the IRS offers virtual currency guidance that provides more insights. Just as with stocks, there are various tax strategies you can use to reduce your tax bill. So enjoy your profits, but don't forget the importance of having a good tax strategy to maximize your wins in the cryptocurrency market. 

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