One of the most common questions I get from investors is how crypto investments like bitcoin are taxed. There seems to be a great deal of confusion, perhaps because of the different names people use for this new asset class.
- If bitcoin is a cryptocurrency … is it taxed like currency?
- If bitcoin is “digital gold” … is it taxed like gold?
- If bitcoin is a commodity … is it taxed like oil?
It's actually not that complicated. Let’s clear things up.
(Note: As with any article that discusses tax treatment, the usual disclaimers apply: This is a generalized overview, does not represent advice, and may not apply to your situation. Do not use this article to make tax or investment decisions. Consult your tax expert.)
How Is Bitcoin Taxed?
The good news is that bitcoin and other crypto assets have just about the best possible tax treatment available for long-term investors. According to the IRS’ official guidance on crypto taxation, crypto is taxed as “property,” which is just a fancy way to say it's taxed like a stock. If you buy bitcoin and hold it for more than a year, you pay long-term capital gains when you sell.
For federal taxes, that means you pay a 15% tax on any gains, unless you make a lot of money (more than $479,000 (for married couples) or $425,800 (for individuals)), in which case you pay 20%.
That compares favorably with almost every other alternative investment.
Gold: Gold is taxed as a collectible. That means, no matter how long you hold it, the lowest tax you can pay when you sell is 28%. And yes, this is true even if you hold a gold exchange-traded fund like the SPDR Gold Shares (GLD); there’s nothing magical about wrapping physical gold in an ETF that changes its tax treatment.
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Currency: Currency is taxed at regular income rates. No matter how long you hold a currency investment like the Invesco CurrencyShares Japanese Yen Trust (FXY), you never qualify for long-term capital gains. Instead, you pay your marginal income tax rate on any gains, up to 37% on federal taxes. Ouch.
Commodity Futures: Commodity futures–and ETFs that hold commodity futures like the US Oil Fund (USO)–are what’s called Section 1256 contracts for tax purposes. That means two things, neither of which are good for long-term investors:
- First, any investment in a Section 1256 contract is “marked to market” at year-end, which means you owe taxes on paper profits at the end of the year even if you don’t sell.
- Second, regardless of your holding period, 60% of any gains are considered long-term capital gains, and 40% are considered short-term capital gains. That means the blended tax rate for someone in the highest federal income tax bracket is 26.8%.
The relatively high tax rate is unfortunate, but it’s the mark-to-market feature that kills long-term investors. People really don’t like paying taxes on paper profits, and the inability to defer taxation can have a meaningful impact on long-term returns. (For short-term investors, Section 1256 contracts can be beneficial, as the 26.8% maximum tax rate is less than the short-term capital gains tax rate (up to 37% for high earners)).
Bitcoin futures, for what it's worth, are considered Section 1256 contracts, so they fall under this tax classification; direct holding of “physical” bitcoin (or investing in a fund that holds bitcoin) does not.
As clear as the core guidelines for crypto taxation are, there are a few areas where more guidance is needed. Fortunately, the IRS recently announced plans to offer guidance on how to handle hard forks and air drops, the right way to establish the cost basis of any crypto position, and other minor topics. (Original note; helpful context.)
The most important thing to remember, however, is that crypto assets like bitcoin are taxed like stocks. If you hold for less than a year, you pay short-term capital gains taxes; if you hold for more than a year, long-term capital gains apply.
[Full disclosure: The author has a long position in bitcoin.]