7 Common Crypto Tax Myths and How to Avoid Them

With just over one week until the 2021 tax deadline in the U.S., it’s really time to button up your return and make sure any crypto activity is accurately reported. Even though crypto tax guidance from the IRS is relatively sparse, judging by page one of Form 1040, the agency has its eyes on cryptocurrencies. Therefore, staying in compliance with the standards that do exist will minimize your chances of getting penalized later on.

To help you avoid any rookie mistakes, here are some common tax myths—and the facts that will help you file correctly.

Myth #1: Crypto is currency.

The basics of crypto tax can boil down to one fact: Crypto is treated as property, not currency, by the IRS. This means cryptocurrencies—virtual assets that facilitate the exchange of value—are treated more like a house than as hard cash. This treatment triggers convoluted property tax rules and words like capital gains that you might’ve seen in ALL CAPS on Twitter.

There are two categories of tax treatments related to crypto: 1) income and 2) capital gains or losses.

Income comes from sources like mining, staking, airdrops, and forks. This revenue is valued in U.S. dollars at the date of receipt and is subject to ordinary tax rates (what your “normal” W2 income is taxed at).

The other side of the coin includes capital gains, which are realized when you sell, trade, or spend crypto. Buying crypto on an exchange is not considered taxable—it’s only when the substance of that coin changes through selling, trading, or spending that Uncle Sam gets grabby. 

Myth #2: Long-term capital gains don't get taxed.

Here’s a simplified breakdown of cap gains:

Capital gain (loss) = value of crypto in USD at disposition - value of crypto in USD at acquisition

The acquisition “value” refers to the cost basis of the coin, or how much you spent to acquire it. There's a nuance between short-term (<12 months) and long-term (>12 months) capital gains. The former are still taxed at ordinary rates while long-term positions are taxed at preferential rates (see the chart below). This means there's an advantage to holding on to assets for at least a year—but you still pay tax.

Myth #3: Staking rewards aren't taxable.

There was a hullabaloo in the crypto tax world (a small community of degen bean counters) when the IRS offered a refund to a couple who sued the agency for taxing their Tezos staking rewards. The plaintiffs were arguing that their staking rewards were akin to a stock split, which is “newly created property” and not taxable. 

Unfortunately, the proposed refund doesn’t mean much because it doesn’t set precedent. If you’re earning staking rewards from delegating to a validator or you’re earning commissions as a validator, those staking rewards are still taxable. The degree to which they’re taxable is debatable (there are conservative to aggressive tax positions you can take) so it depends on what risk appetite you have.

To be on the safe side, I recommend treating all staking rewards as ordinary income. Most token tracking softwares have a setting of “Treat rewards as income?,” so you can always switch this off if guidance changes.

Myth #4: NFTs don't count.

2021 was the peak of NFT mania, but many collectors are in for a surprise. Buying an NFT with cryptocurrency is considered a taxable event, and capital gains rules apply. Selling or swapping an NFT triggers the same treatment—you only escape NFT taxes if you 1) donate the NFT, 2) buy it with fiat currency, 3) mint it, or 4) gift it (under a $15,000 ceiling). 

And although NFTs are considered the collectibles of Web3, they are not subject to the rules governing “meatspace” collectibles yet. Collectibles, if held greater than one year, can be taxed up to 28%, which is more than the highest capital gains bracket (collectibles held for under a year are taxed at ordinary rates).

The IRS specifically calls out “coins and art” in the collectibles section of the IRC, so expect more clarification to come once the IRS figures out what an NFT is.

Myth #5: Wash sales rules apply to crypto.

As explained by Fidelity, “The wash-sale rule prohibits selling an investment for a loss and replacing it with the same or a 'substantially identical' investment 30 days before or after the sale.”

While wash sales typically apply to stocks and securities, crypto is treated as property for tax purposes, meaning this old-school rule doesn’t apply. This means you can technically maximize your losses by buying and reselling as frequently as you want. Although taxpayers can only take a maximum loss of $3,000, any excess losses carry over and can be used to offset future gains from crypto and other capital assets. 

Myth #6: Airdrops aren't taxable.

Everyone and their mother got an ENS airdrop this year. And while the frosted-blue token looks great, the tax consequences aren’t so pretty. If you claimed your airdrop in 2021, you earned income equal to the number of ENS multiplied by the exchange price on the day claimed. ENS debuted at $43.44 and rocketed to a high of $83.40, so depending on when you claimed it, there’s a definite price tag attached. 

Airdrops are sneaky because even if you received a random token in your wallet, it counts as income and is subject to ordinary tax rates (assuming it has value). If you subsequently dispose of the airdropped asset, you are also taxed through capital gains.

To avoid airdrop tax evasion, check your wallets frequently to see if there are any new tokens that magically appeared. Taxes don’t kick in until you can “transfer, sell, exchange, or otherwise dispose of the cryptocurrency” so check if your exchange account even supports the airdropped token. If not, don’t worry about recording the income until there’s pricing and a liquid market.

Myth #7: Software solves everything.

Software certainly helps, but it doesn't yet cover every situation.

Although all data is technically on the blockchain, extracting that data and making it palatable isn’t always simple. Ethereum-based transactions are easier since most crypto tax software are compatible with EVM chains. However, if you’re transacting on less-popular chains like FLOW, NEAR, or Oasis, data can be scant and difficult to work with. Providers like Cointracker or Koinly do not support automatic integrations of these assets because of their lower volume, so manual imports are necessary. 

If you’re lurking on random sidechains or are a multi-chain maximalist, build out a comprehensive data plan so you’re not left googling “How to build a python scraper” on April 17th. To avoid the last minute tax scramble, I recommend getting an automated token tracker ASAP and setting aside time each month to review and add manual transactions if needed.

The tips above should help with sifting through your transactions and seeing what’s taxable. If you’re curious to learn more about crypto taxes, there are plenty of resources at Decrypt. I also recommend taking the “What You Really Need to Know About Crypto Taxes” course by the Crypto Tax Girl. It’s bursting with obscure but practical tax knowledge. 

Happy tax season!