Guide · Crypto & Web3
Crypto Taxes Explained: Capital Gains, Income, and How to Prepare
The days of tax-free crypto trading are long gone. Tax authorities worldwide now have strict rules on how crypto transactions must be reported. Here is how to stay compliant.
Capital Gains vs. Ordinary Income
Cryptocurrency taxation generally falls into two buckets. It is crucial to understand which actions trigger which type of tax, as ordinary income is typically taxed at a much higher rate than long-term capital gains.
- Capital Gains: Triggered when you dispose of an asset. This includes selling crypto for fiat (USD/GBP), trading one crypto for another crypto, or using crypto to buy goods and services. You are taxed on the profit (the difference between what you paid for it and what you sold it for).
- Ordinary Income: Triggered when you earn crypto. This includes receiving mining rewards, staking rewards, yield farming interest, airdrops, or being paid your salary in crypto.
The "Crypto-to-Crypto" Tax Trap
The most common mistake new investors make is assuming that taxes are only due when they "cash out" to a bank account. This is false.
If you buy $1,000 of Bitcoin, it goes up to $5,000, and you trade that Bitcoin directly for Ethereum, you have triggered a taxable event. The IRS views this as you selling your Bitcoin for $5,000, realizing a $4,000 capital gain, and then buying $5,000 of Ethereum. You owe taxes on that $4,000 gain for the year the trade occurred, even if the Ethereum later crashes to zero before tax season.
Cost Basis and Accounting Methods
To calculate your capital gains, you need to know your Cost Basis (what you originally paid for the asset, plus any trading fees). When you sell a fraction of your holdings, you must use an accounting method to determine which specific coins you sold.
FIFO (First In, First Out) is the default and most common method used by tax authorities. It assumes the first coin you bought is the first coin you sell. HIFO can be used to minimize current taxes by selling your most expensive coins first, but it requires strict record-keeping.
How to Prepare for Tax Season
Doing crypto taxes manually with a spreadsheet is nearly impossible if you trade frequently, use decentralized exchanges (DEXs), or move funds between wallets.
The best approach is to use crypto tax software. You connect read-only API keys from your exchanges and paste your public wallet addresses. The software aggregates all your transactions, matches transfers between your own accounts (which are non-taxable), and generates the required tax forms (like the IRS Form 8949).
Frequently asked questions
Do I have to pay taxes on cryptocurrency?
Yes. In most jurisdictions (including the US, UK, and Canada), cryptocurrency is treated as property or a capital asset for tax purposes. This means you must report capital gains when you sell or dispose of crypto, and income when you earn crypto.
Is trading one crypto for another a taxable event?
Yes. If you trade Bitcoin for Ethereum, tax authorities view this as two transactions: selling your Bitcoin for its fair market value in fiat currency (which triggers a capital gain/loss), and then using that fiat to buy Ethereum.
Do I owe taxes if I just hold my crypto in a wallet?
No. Simply buying cryptocurrency with fiat money and holding it in a wallet or on an exchange is not a taxable event. You only owe tax when you sell, trade, or otherwise dispose of it.
How are staking rewards and airdrops taxed?
Staking rewards, mining rewards, and airdrops are generally taxed as ordinary income at their fair market value on the day you receive them. When you later sell those coins, you will also incur capital gains taxes based on the change in price from the day you received them.