When an individual holds a crypto asset there are four different tax buckets a future sale or exchange could fall into with regards to capital gains or losses. The four categories are taxed differently and placed in different parts of the Form 8949 for reporting purposes. The four categories are short-term capital gains which are taxed at an ordinary income rate, short-term capital losses which are taxed at an ordinary income rate, long-term capital gains which are taxed at the capital gains rate, and long-term capital losses which are taxed at the capital gains rate. In this article we explore the details of holding periods which will tell the taxpayer whether his/her capital gains or losses are short-term or long-term.
If an individual holds a crypto asset for one year or less, the gains or losses associated with a sale or exchange of that crypto asset will be considered short-term capital gains or losses. Short-term capital gains or losses are reported in Part I of the Form 8949. Conversely, if an individual holds a crypto asset for more than one year, the gains or losses associated with a sale or exchange of that crypto asset will be considered long-term capital gains or losses. Long-term capital gains or losses are reported in Part II of the Form 8949. An individual’s holding period begins the day after he/she acquires the crypto asset. However, an individual’s holding period includes the day the individual sells or exchanges the crypto asset.
Importantly, an individual who holds a futures contract in a crypto asset will include the period for which the individual held the futures contract when calculating the length of the holding period. For example, suppose McGee purchased a futures contract from Riley on May 4, 2020. The contract granted McGee the right to purchase one bitcoin for $15,000 on May 10, 2021. On May 10, 2021 the price of bitcoin was at $40,000 so McGee and Riley settled the futures contract by exchanging $25,000 in cash. In this case, McGee’s holding period would begin on the day after the futures contract was executed, May 5, 2020. Therefore, when McGee settles the futures contract on May 10, 2021 he would have held the contract for more than one year. As a result, the $25,000 in gains would be treated as long-term capital gains.
Individuals holding regulated futures contracts may be able to take advantage of IRC section 1256. This IRC section allows individuals to treat 60 percent of their futures contracts as long-term and the other 40 percent as short-term so long as certain conditions regarding the contract are satisfied regardless of how long the regulated futures contract is held. For those participating in crypto day trading this can produce a massive tax advantage rather than taking all of an individual’s gains or losses as short-term. A future publication will explore the intricacies of IRC section 1256.
Long-term capital gains are taxed at a preferential rate of 0 percent for a single individual whose income is below $40,401 (below $80,801 for a married individual filing jointly) in 2021, 15 percent for a single individual whose income is more than $40,400 but less than $445,851 (more than 80,800 but less than $501,601 for a married individual filing jointly), or 20 percent for a single individual whose income is more than $445,850 (more than $501,600 for a married individual filing jointly). Short-term capital gains are taxed at the taxpayer’s less advantageous ordinary income rate which can be up to 39.6 percent. Thus, being able to sell and utilize the shelter of long-term capital gains is generally a tax efficient strategy.
An individual may also be responsible for the net investment income tax (NIIT) of 3.8 percent if his/her modified adjusted gross income (MAGI) exceeds the NIIT threshold amount. In 2021 the NIIT threshold amount is $200,000 for a single individual ($250,000 for a married individual filing jointly). Therefore, to calculate the NIIT tax one would determine the individual’s MAGI then reduce that number by the applicable NIIT threshold amount. The product of the number in the preceding sentence and 3.8 percent will produce the individual’s NIIT tax amount which would be reported on Form 8960.
Accurately determining an individual’s holding period is critical to properly reporting crypto taxes. As we have stressed in our prior publications, it is critical that an individual keeps meticulous records regarding when a crypto asset is acquired. Having an asset classified as long-term allows a user to have preferential tax treatment and, is generally, but not always, preferable to having an asset classified as short-term. If you have any questions regarding the topics discussed in this article, please contact us.
