The price of Bitcoin has nearly doubled this year, though that looks downright paltry when compared with a whopping 47,000,000% spike — yes, that’s 47 million — for the Shiba Inu coin. If you’re among the 16% of Americans whom Pew Research estimates have invested in, traded or used a digital coin, then you could face tax bills come April.

As with stocks, investors are on the hook to pay federal taxes on cryptocurrency profits. Virtual currencies are deemed property by the Internal Revenue Service, and investors must pay taxes on any capital gains — and the rate depends on how long you owned the coin before selling. Short-term capital gains on assets held less than one year are taxed like income, with tax rates for 2021 ranging from 10% to 37%, depending on your income. Meanwhile, most investors must pay a 15% or 20% tax rate on long-term capital gains for assets owned for more than a year.

The IRS does make an “interesting” distinction with cryptocurrencies versus other assets: If you were paid in a virtual coin, then you’ll have to account for payments as income, notes Scott Kellter, portfolio manager at Envestnet. For example, if you mine Bitcoin and earn payment in Bitcoin in exchange, you need to report that payment as income at its value (in U.S. dollars) when earned, he adds. And then you’re taxed again if you sell the coins you mined.

“The way I think about it is: The way you use your cryptocurrency is the way it’s taxed,” adds Lisa Greene-Lewis, a certified public accountant and the editor of the TurboTax Blog. That said, if you bought digital coins in the past year but haven’t sold yet, you won’t have to pay any taxes on those investments, she says.

How to report crypto profits to the IRS

If you’ve reported capital gains on other investments in the past, you’ll need the same information for cryptocurrency investments: The dates you bought and sold, along with your cost basis (the original price paid) and the amount of profit or loss.

“It seems as though crypto investors tend to be younger and tend to be more active with trading,” Keller notes. “If they have hundreds of transactions they have to account for, then it can be a bit of a hairy process.”

While investors should receive a Form 1099 with the necessary information to report crypto-related capital gains and losses, there’s a chance you won’t. The most popular U.S.-based brokers — including Coinbase and Robinhood — will supply this tax form, which makes for a “really clean and easy” reporting process when filing your tax returns, Keller says. But these platforms aren’t yet required to report tax information to customers, so there’s a chance you may need to self-report capital gains and losses, Greene-Lewis adds.

Things get more complicated if you move digital coins from one exchange to another, in which case the accounting information may be inaccurate, Keller cautions. “It is highly recommended that investors in cryptocurrencies track everything on their own,” he says, adding that this information will also be valuable if the IRS changes its tax treatment for cryptos in the future. “Make the transaction accounting a priority.”

Many tax software programs allow taxpayers to upload financial information from a variety of financial institutions. And TurboTax recently debuted a cryptocurrency tax calculator.

Because you’re also obligated to pay taxes for spending cryptocurrency, it’s important to keep a good track record of those transactions. In the eyes of the IRS, the gain is the difference between the dollar value of what you received and the cost of the virtual currency you bought it with, Greene-Lewis says.

Finally, don’t forget about state taxes. A majority of states treat capital gains like ordinary income, meaning that you’ll be taxed at a higher rate when filing your state taxes. If you live in California, prepare to pay an additional 1% to 13.3% on your crypto capital gains, depending on your income. But eight states, including Florida and Washington, don’t have any income tax.

How to lower your crypto tax bill

With only a few weeks left in the year, investors may want to consider a popular strategy known as tax-loss harvesting. The IRS only cares about net trading profits — including for stocks, bonds, exchange-traded funds (ETFs), mutual funds and cryptocurrencies — you can sell an investment at a loss to offset investment gains elsewhere or up to $3,000 in income. And these losses can be carried forward to offset investment gains in future years.

Because the IRS has treated cryptocurrencies as property, however, the wash-sale rule doesn’t apply. This rule dictates that if you sell an investment at a loss, the IRS doesn’t let you count the loss for tax purposes if you rebuy it, or a “substantially identical” asset, within a 30-day period. Savvy crypto investors found a tax loophole: A like-kind exchange, which allows you to sell a coin at a loss and instantly buy it again, Keller says. If passed, a bill currently working through the U.S. Congress could make the wash-sale rule apply to crypto, he adds.

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