One of the most common doubts in the crypto tax world is if you have to pay taxes on crypto-to-crypto trades. In the US, all crypto-to-FIAT trades pay taxes, but what about crypto-to-crypto trades?
Many assume that a crypto-to-crypto transaction is not taxable because, even if you make a profit, since you don’t cash out into FIAT.
For clarification on your tax obligations as a crypto holder, check out our comprehensive guide about which crypto events are taxable.
In this article:
So, are crypto-to-crypto trades taxable?
According to the IRS guide, crypto is considered property, and if you convert property (e.g., virtual currency) for another virtual currency, you need to recognize a “capital gains or loss.”
Even though you do not sell your crypto into FIAT, you still need to pay capital gains taxes if your crypto-to-crypto transaction was at a profit. As a result, your tax planning ahead of making these trades is crucial to avoid not having enough money to pay your taxes.
A first good step is to track and record all your trades in a crypto tax software that automates this process for you.
If you trade a lot of altcoins against Bitcoin and make a profit on those trades but do not cash out any of the gains into USD, you could be in a difficult position when the time comes to pay taxes on those altcoins/BTC trades.
How to calculate taxes on crypto-to-crypto profitable trades?
Let’s imagine you’re buying AAVE with Bitcoin. When you convert Bicoin into AAVE, it is considered as two transactions:
1. Selling Bitcoin
The first transaction is selling your Bitcoin for the market value at the time of the trade. The gain/loss for that transaction is the difference between the fair market value and the basis cost when you originally bought Bitcoin.
2. Purchasing AAVE
The second transaction is buying the new cryptocurrency (AAVE) for the amount (fair market value/sales proceeds) that you sold your Bitcoin.
Even though there was no fiat involved, you still need to recognize a gain or loss for the deemed sale of the Bitcoin that you use to exchange for AAVE.
A tax scenario: Sophia makes an AAVE/BTC trade
In December 2020, Sophia bought 0.1 BTC for $2K. At that time, 1 Bitcoin was worth $20K.
On January 25, Sophia sold 0.1 BTC for $3.1K because she wants to buy AAVE. At that time, 1 BTC was worth $31K.
The taxation of this transaction is based on 2 steps:
1. Sophia needs to recognize a gain from selling Bitcoin to buy AAVE
Profit in the transaction = $3,100 – $2,000 = $1,100
Projected Capital gains Tax on that transaction = $1,100 x 35% (short-term capital gains tax*) = $385*
*Short-term capital gains tax rates range from 10% to 37% in the US. We assume a 35% short-term capital gain tax for simplicity purposes in this hypothetical scenario. However, these rates and your capital gains taxes to be paid are merely indicative as the real ones will depend on your total income level, tax exceptions, deductions, thresholds, family status (married/single) among other factors as a US taxpayer.
2. Sophia buys AAVE
Sophia bought 15.5 AAVE with 0.1 BTC. Her cost basis in the 15.5 AAVE equaled $3,100, the sales proceeds from the deemed sale of her BTC. In other words, each AAVE was worth $200 at the time of the trade.
Remember, Sophia didn’t convert her BTC into USD but rather used it to buy AAVE. However, she’ll have to pay $385 in taxes. As a result, Sophia needs to carefully plan her trades to make sure she has enough money to cover her tax bill. She will need to cash out some of her crypto, unless she has enough money from somewhere else.
What if Sophia makes a profit on the AAVE trade?
If AAVE gains in price and Sophia sells it back into Bitcoin, she’ll enter in another crypto-to-crypto trade.
On top of the initial taxes paid from the deemed sale of her Bitcoin, Sophia will also have to pay capital gains tax from profit on the sale of her AAVE. She would have a lower tax bill if she held her AAVE for more than 12 months.
*This post is part of the Crypto Taxes AMA series. Follow our weekly AMAs on Twitter where our expert CPA, Sharon Yip answers your crypto tax questions.
Seems a bit complicated, right?
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If you need personalized help reviewing your transactions or preparing your US tax returns, check out our CoinTracking Full Service, provided by a team of crypto tax professionals led by Sharon Yip, the export CPA who helped us put together these insights.
Check our guides on how to comply with crypto taxes:
How to report crypto in your taxes?
Earn Interest on Crypto: The Taxes Guide.
Do you pay taxes on Bitcoin debit cards purchases?
How to calculate taxes with Bitcoin dollar-cost averaging?
How Crypto tax laws save money for Bitcoin hodlers
2021’s NFT guide (with taxes).
Is Bitcoin taxable? The ultimate guide for 2021 taxes.
Tax implications of getting paid in Crypto.
Bitcoin Millionaire? An inheritance plan for wealth.. with taxes.
Disclaimer: All the information provided above is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.