How to Take Profit From Crypto and Pay Taxes

Taking profit from cryptocurrency involves converting digital assets into fiat currency, such as U.S. dollars. The Internal Revenue Service (IRS) generally regards cryptocurrency as property, similar to stocks or bonds. This means its disposition can trigger taxable gains or losses.

Identifying Taxable Crypto Activities

Several actions involving cryptocurrency are considered taxable events. Selling crypto for fiat currency, like U.S. dollars, is a primary taxable event. Trading one cryptocurrency for another, such as Bitcoin for Ethereum, is also a taxable disposition. Using crypto to purchase goods or services also triggers a taxable event, as it’s viewed as selling the crypto for its fair market value.

Receiving cryptocurrency can also constitute taxable income. Earnings from mining are considered ordinary income based on the fair market value at the time of receipt. Rewards from staking, where individuals hold crypto to support a blockchain network, are also taxed as ordinary income upon receipt. Crypto received from airdrops or yields from decentralized finance (DeFi) protocols are typically taxable income. Any disposition or receipt of crypto as income can trigger a tax event, requiring reporting.

Determining Crypto Cost Basis and Gains

Calculating the gain or loss from cryptocurrency transactions is a crucial step for tax reporting. Cost basis is the original purchase price of the asset, including any acquisition fees. Gain or loss is determined by subtracting this cost basis from the sales price (or fair market value at disposition). If the sales price exceeds the cost basis, a capital gain results; if lower, a capital loss is incurred.

When an investor acquires the same cryptocurrency through multiple purchases at different prices, determining the cost basis for a specific sale requires an accounting method. While methods like First-In, First-Out (FIFO) and Last-In, First-Out (LIFO) exist, Specific Identification is often most advantageous. This method allows investors to choose which specific units are sold, potentially minimizing taxable gains by selecting units with a higher cost basis or longer holding period. However, beginning January 1, 2025, investors must use a wallet-by-wallet accounting method, and FIFO is expected to become mandatory for all identification methods starting in 2026.

The holding period dictates whether gains are short-term or long-term capital gains. Assets held for one year or less result in short-term gains, taxed at ordinary income rates (10% to 37%). Assets held for more than one year yield long-term gains, taxed at 0%, 15%, or 20%, depending on the taxpayer’s income. Meticulous record-keeping is essential for all transactions, including dates, amounts, prices, and fees, as accurate calculations depend on this information.

Executing Crypto-to-Fiat Conversions

Converting cryptocurrency into fiat currency typically involves several steps through a reputable exchange. After identifying taxable activities and calculating potential gains or losses, access an exchange that supports direct fiat withdrawals to a linked bank account. Most major exchanges offer this functionality. The process begins by navigating to the trading section and selecting the cryptocurrency to sell.

Investors can choose between different types of sell orders: a market order or a limit order. A market order executes immediately at the current market price. A limit order allows the investor to set a specific price, executing only when that price is met or exceeded. Once the sell order is placed and executed, the cryptocurrency converts into fiat currency, appearing in the exchange’s fiat wallet. This completes the taxable disposition.

The final step involves initiating a fiat withdrawal from the exchange to a linked bank account. This usually requires verifying bank account details, which may involve small test deposits or other security measures. Withdrawal limits, both daily and monthly, are common and vary by exchange. Associated fees for withdrawals can also apply, typically a small percentage or a flat fee. Processing times generally range from one to five business days, depending on the exchange and banking institutions.

Fulfilling Crypto Tax Reporting Requirements

After converting cryptocurrency and calculating gains or losses, accurately report these amounts. For capital gains and losses from crypto transactions, taxpayers typically use IRS Form 8949, “Sales and Other Dispositions of Capital Assets.” This form requires detailing each crypto transaction, including acquisition date, sale date, proceeds, and cost basis, separating them into short-term and long-term categories. Totals from Form 8949 are then summarized on Schedule D (Form 1040), “Capital Gains and Losses,” which consolidates all capital gains and losses for the tax year.

Cryptocurrency received as income, such as from mining, staking, or airdrops, is generally reported as ordinary income. This income is typically reported on Schedule 1 (Form 1040), “Additional Income and Adjustments to Income,” or, if a business activity, on Schedule C (Form 1040), “Profit or Loss from Business.” While some exchanges may issue Form 1099-B, its utility for crypto is often limited, as it may not accurately reflect the cost basis or all transaction types. Taxpayers bear the ultimate responsibility for accurate reporting, regardless of whether a 1099 form is received.

Maintaining comprehensive transaction records is paramount for tax audit purposes, providing documentation for every acquisition, disposition, and income event. These records should include transaction dates, amounts, fair market values at the time of transaction, and any associated fees. Various crypto tax software tools are available to assist with organizing these records and generating necessary tax forms. These tools can import transaction data from multiple exchanges and wallets, calculate gains and losses, and generate IRS-compliant reports and forms, streamlining the reporting process.