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Cost Basis and Capital Gains Tax Rules When Selling Inherited Cryptocurrency
Cost Basis and Capital Gains Tax Rules When Selling Inherited Cryptocurrency
Hey there! Dealing with cryptocurrency taxes can be super confusing, am I right? Especially when it comes to inherited crypto. Don’t worry – I’m here to walk you through the key tax rules and help make sense of this complex topic.
First things first: The IRS treats cryptocurrency as property for tax purposes, not as currency[1]. That means when you sell or exchange crypto, it can generate either capital gains or capital losses – just like when you sell stocks or real estate.
Now, when you inherit cryptocurrency, you also inherit the cost basis of the person who gifted it to you[1]. This cost basis is important because it will determine how much capital gains tax you owe when you eventually sell the crypto.
Determining the Cost Basis of Inherited Crypto
The cost basis of inherited cryptocurrency is generally the fair market value on the date of the original owner’s death[1]. So if Uncle Joe bought 1 Bitcoin for $5,000 and gifted it to you when it was worth $50,000, your cost basis would be $50,000.
It gets trickier if the original owner didn’t purchase their crypto – say they received it through mining or as payment for goods/services. In that case, your inherited cost basis is entirely dependent on the fair market value on the day the original owner died[2].
The executor of the estate should provide you documentation detailing the cost basis of any inherited cryptocurrency. If not, you may need to do a bit of research on historical exchange rates to determine the fair market value on the date of death[3].
Calculating Capital Gains on Inherited Crypto
Once you know your inherited cost basis, you can calculate capital gains when you sell the crypto. It’s simple:
- Selling Price – Cost Basis = Capital Gain
For example, say you inherited 1 Ethereum from Grandma with a cost basis of $1,000. You later sold that 1 Ethereum for $3,000. Your capital gain would be $3,000 – $1,000 = $2,000.
One important thing to note – inherited cryptocurrency always gets long-term capital gains treatment, no matter how quickly you sell it after inheriting. Long-term capital gains tax rates are 0%, 15% or 20% depending on your income[4].
Using the FIFO Method for Inherited Crypto
Let’s say Grandpa didn’t just gift you 1 Ethereum, but rather his entire Ethereum wallet containing crypto purchased at different times and different prices.
In this case, you need to identify which specific Ethereum were sold to accurately calculate capital gains. The IRS requires using the FIFO (First In, First Out) method[5].
So the Ethereum with the earliest purchase date would be considered the first sold, followed by the next oldest, and so on. Each lot sold has its own individual cost basis and capital gain.
This can get super complex if the inherited wallet contains tons of crypto purchased across many dates. But just take it slow and match up purchases and sales by date as best as you can.
Reporting Capital Gains on Inherited Crypto
You must report any capital gains from selling inherited cryptocurrency on IRS Form 8949. The totals from Form 8949 get carried over to Schedule D and then to your Form 1040[6].
Don’t forget – you can claim up to $3,000 in net capital losses each year to offset regular income. Any remaining losses carry forward to future tax years.
It’s generally wise to consult a tax pro if you’ve inherited a large or complex crypto portfolio. An expert can help ensure you accurately calculate cost basis, capital gains, and loss carryovers.
Tax-Free Gifting of Cryptocurrency
Let’s shift gears and talk about gifting crypto while you’re still alive. This can be a smart way to transfer wealth to loved ones without triggering income or capital gains taxes.
The IRS allows you to gift up to $16,000 per person per year in cryptocurrency without needing to file a gift tax return. And the recipient inherits your cost basis, so no taxes are due on the transfer.
You can gift amounts over $16,000 as well. You just need to file a gift tax return, but still won’t owe any gift tax until the lifetime exemption of $12.06 million is exceeded.
One word of caution – the IRS may scrutinize cryptocurrency gifts more heavily to ensure they are true gifts, not disguised sales. So be sure to fully transfer ownership and control to the recipient.
Avoiding Crypto Tax Pitfalls
Hopefully this gives you a solid grounding on the key tax rules for inherited cryptocurrency. Just remember these key points:
- Inherited crypto gets a cost basis equal to the fair market value on the date of death
- Selling inherited crypto triggers long-term capital gains (or losses)
- Use the FIFO method if selling from an inherited wallet
- Report capital gains on Form 8949 and Schedule D
- Lifetime gifts under $16,000 are tax-free
Cryptocurrency tax law is complex and still evolving. So be sure to consult a tax pro if you have questions or a particularly complicated crypto inheritance situation.
The last thing you want is to run afoul of the IRS and end up with penalties for incorrect reporting. A tax professional can help ensure you stay compliant, report accurately, and maximize your tax savings.
I hope this overview gives you confidence in handling cryptocurrency inheritance and taxes. Reach out anytime if you need help getting a handle on your specific crypto tax scenario!
References
[1] https://www.bankrate.com/investing/crypto-taxes-guide-bitcoin-ethereum/
[2] https://www.coindesk.com/learn/crypto-capital-gains-and-tax-rates-2022/
[3] https://koinly.io/cryptocurrency-taxes/
[5] https://www.kiplinger.com/investing/making-a-killing-in-cryptocurrency-theres-a-tax-on-that
[6] https://www.schwab.com/learn/story/cryptocurrencies-and-taxes-what-you-should-know