How to Cash Out Cryptocurrency: Steps and Tax Rules

Cashing out cryptocurrency involves converting digital assets into traditional fiat currency, such as US dollars. This process is common for holders seeking to realize profits, access funds, or reallocate investments. This guide provides an overview of converting cryptocurrency into spendable funds.

Essential Preparations Before Cashing Out

Before initiating any cash-out, several preparatory steps ensure a smooth and secure transaction. These steps help comply with regulations, set up payment channels, and protect your assets. Completing these preparations prevents delays and complications.

Identity Verification (KYC/AML)

Cryptocurrency platforms are subject to Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations, similar to traditional financial institutions. These rules require platforms to verify user identity to prevent illicit activities like fraud and money laundering. You will need to provide personal information and documents for verification.

Required documentation usually includes a government-issued identification, such as a driver’s license or passport, and proof of address, like a utility bill or bank statement. Some platforms may also request a selfie or video verification.

Linking Payment Methods

Connecting a traditional bank account or other payment service to your cryptocurrency exchange is a fundamental step for cashing out. This linkage allows the platform to transfer fiat currency to you after your cryptocurrency has been sold. The process typically involves securely adding your bank account details, such as the account number and routing number, to your exchange profile.

Many exchanges may require a small deposit or verification transaction to confirm the linked account belongs to you, ensuring funds are sent to the correct recipient. Some platforms also support linking debit cards or digital payment services like PayPal, offering flexibility in withdrawal options.

Understanding Fees

Various fees are associated with cashing out cryptocurrency, and understanding them helps calculate the net amount you will receive. These can include trading fees for selling your cryptocurrency, often a percentage of the transaction value. Withdrawal fees are also common, charged when you transfer fiat currency from the exchange to your linked bank account.

Network fees, also known as gas fees, are charged for transactions on the blockchain and can fluctuate based on network congestion. Some exchanges may also have spread fees, built into the exchange rate, representing the difference between buy and sell prices. Reviewing the platform’s fee schedule helps anticipate costs and choose the most cost-effective method.

Security Best Practices

Protecting your funds and personal information is important throughout the cashing out process. Employing strong, unique passwords for all your cryptocurrency accounts is a security measure. Enabling two-factor authentication (2FA) using an authenticator app, rather than SMS, adds protection against unauthorized access.

Remaining vigilant against phishing attempts, verifying email and website legitimacy, using secure internet connections, and regularly reviewing account activity helps safeguard assets and reduce the risk of security breaches and financial loss.

Choosing a Cashing Out Method

Once preparatory steps are complete, you can select from various methods to convert your cryptocurrency into fiat currency. Each method offers different levels of convenience, speed, and costs, allowing you to choose the option that best suits your needs. The choice often depends on the amount you wish to cash out and your preference for directness versus convenience.

Centralized Cryptocurrency Exchanges (CEXs)

Centralized exchanges are a common method for cashing out cryptocurrency, providing a structured environment to sell digital assets for fiat currency. After logging in, navigate to the trading section and select the cryptocurrency you wish to sell. You can place a market order to sell at the current prevailing price or a limit order to sell at a specific price.

Upon successful execution of your sell order, the fiat currency equivalent will be credited to your account balance on the exchange. From there, you can initiate a withdrawal to your previously linked bank account or other payment method. Bank transfers, such as ACH transfers in the US, typically take 1 to 5 business days to process. Wire transfers often clear within the same or next business day for domestic transfers.

Peer-to-Peer (P2P) Platforms

Peer-to-peer (P2P) platforms facilitate direct transactions between individual buyers and sellers of cryptocurrency. On these platforms, you can create an offer to sell your cryptocurrency at a desired price and specify your preferred payment method, such as a bank transfer or cash. Buyers can then view your offer and, if interested, initiate a trade.

The platform typically holds the cryptocurrency in an escrow service until the buyer confirms receipt of payment. This escrow mechanism provides a layer of security for both parties. P2P platforms offer flexibility in payment options and can sometimes provide better exchange rates compared to centralized exchanges, but they require direct interaction and verification of payment outside the platform.

Cryptocurrency ATMs

Cryptocurrency ATMs offer a way to convert cryptocurrency directly into physical cash. These machines are often located in retail establishments and operate similarly to traditional ATMs. To cash out, you select the option to sell cryptocurrency, specify the amount, and then send the cryptocurrency from your digital wallet to the address provided by the ATM, often via a QR code.

Once the transaction is confirmed on the blockchain, the ATM dispenses the corresponding cash. Bitcoin ATMs usually charge higher fees, often ranging from 5% to 25% of the transaction amount, and may have daily transaction limits (e.g., $3,000-$10,000). While offering immediate access to cash, their higher fees and transaction limits are a consideration.

Crypto Debit Cards

Crypto debit cards provide a convenient way to spend your cryptocurrency by converting it to fiat currency at the point of sale or ATM withdrawal. These cards are typically linked to a cryptocurrency exchange account or a dedicated crypto wallet. When you make a purchase or withdrawal, the card issuer instantly converts the necessary amount of cryptocurrency into the local fiat currency.

These cards function like regular debit cards, accepted anywhere major card networks are. Fees can include conversion fees, ATM withdrawal fees, and sometimes monthly maintenance fees. While offering ease of use for everyday spending, be aware of any daily spending or withdrawal limits set by the card issuer.

Understanding Tax Obligations

Cashing out cryptocurrency has tax implications that must be understood and properly reported to tax authorities. The Internal Revenue Service (IRS) generally treats cryptocurrency as property for tax purposes, similar to stocks or other capital assets.

Capital Gains and Losses

When you sell cryptocurrency for fiat currency, it is considered a taxable event, resulting in either a capital gain or a capital loss. A capital gain occurs if you sell the cryptocurrency for more than its cost basis, which is generally the price you paid for it, plus any associated fees. Conversely, a capital loss occurs if you sell it for less than its cost basis.

Short-Term vs. Long-Term

The tax rate applied to your capital gains depends on how long you held the cryptocurrency before selling it. If you held the cryptocurrency for one year or less, any profit is a short-term capital gain. Short-term capital gains are taxed at your ordinary income tax rates, which can range from 10% to 37%.

If you held the cryptocurrency for more than one year before selling, any profit is a long-term capital gain. Long-term capital gains are generally taxed at more favorable rates, typically 0%, 15%, or 20%, depending on your overall taxable income. This distinction can impact your tax liability, encouraging a longer holding period for investment assets.

Record-Keeping

Accurate record-keeping for all cryptocurrency transactions is important for tax reporting. Maintain records of the acquisition date, cost basis (including purchase price and fees), disposition date, and proceeds received from each sale. This information is necessary to correctly calculate your capital gains or losses and helps substantiate your tax calculations if reviewed by tax authorities.

Reporting Requirements

Taxpayers must report all cryptocurrency transactions on their annual tax returns. Capital gains and losses from cryptocurrency sales are typically reported on IRS Form 8949, Sales and Other Dispositions of Capital Assets. The totals from Form 8949 are then summarized on Schedule D, Capital Gains and Losses, which is filed with your Form 1040. While some exchanges may issue tax forms like Form 1099-B, taxpayers are ultimately responsible for ensuring all transactions are accurately reported, even if they do not receive such forms.