Do you have to pay crypto taxes if you reinvest?

Imagine earning $500,000 in crypto profits, whether from Bitcoin (BTC), Ethereum (ETH), or any of the more than 22,000 digital currencies that currently exist. Naturally, you might be eager to start spending.

But what if you decide to reinvest those profits instead of cashing out? How would that affect your tax liability?

In this guide, we’ll explain taxes on crypto gains, whether you have to pay taxes on crypto if you reinvest, and other broader crypto tax considerations.

Understanding crypto reinvesting and taxes

Reinvesting profits from crypto trades into more cryptocurrency, rather than converting them to fiat currency, can potentially increase capital gains by compounding returns over time. Traders often use this strategy because it’s particularly effective in volatile markets where price swings present significant profit opportunities. The goal is to capitalize on short-term gains by continuously reinvesting to maximize market movements.

However, tax obligations apply whether you reinvest your crypto gains or cash out. The Internal Revenue Service usually treats reinvestments as taxable events, meaning you’ll likely owe taxes on any profits when you reinvest. Think of it as if you’re selling your crypto for cash and then using that cash to reinvest. The first part of that process – selling the original crypto – triggers the taxable event. So even if you reinvest right away, you might still face tax responsibilities because the IRS taxes gains at the point of sale or trade.

How to calculate crypto gains for taxes

Calculating cryptocurrency taxes involves determining the gain (or loss) of each transaction, which requires knowing the cost basis and gross proceeds for each sale or exchange. The cost basis is the original purchase price plus any associated fees. The gross proceeds represent the fair market value of the assets received at the time of sale or exchange, minus any fees. Capital gains are calculated by subtracting the cost basis from the gross proceeds, representing the taxable income from cryptocurrency transactions.

Ways to reinvest crypto and their tax implications

When reinvesting cryptocurrency, traders have various options, each carrying specific tax implications. Whether swapping one digital asset for another, purchasing NFTs, or reinvesting staking rewards, the IRS generally treats these activities as taxable events. 

Here’s a closer look at how different crypto reinvestment strategies work and the associated tax responsibilities:

Swapping one crypto for another

Investors can swap one virtual currency for another on cryptocurrency exchanges like Coinbase, Binance, or Kraken. To do this, they select the currencies to trade, specify the amount, and execute the transaction. The exchange handles the conversion based on current market rates.

When swapping cryptocurrencies, the IRS treats it as if the investor sold one cryptocurrency and purchased another. This means that capital gains tax applies, again, based on the difference between the original purchase price (the tax basis) and the fair market value of the crypto at the time of the swap. For example, if you originally bought 1 ETH for $1,000 and later swapped it for another cryptocurrency when its market value was $2,500, you would report a $1,500 capital gain.

Using cryptocurrency to buy an NFT

NFT marketplaces like OpenSea allow users to purchase digital assets with cryptocurrency. Buyers select the desired NFT, connect their crypto wallet, and complete the transaction using their chosen virtual currency. 

The IRS views buying an NFT with cryptocurrency as selling the cryptocurrency to acquire the NFT, which means the difference between the cryptocurrency's original purchase price and its fair market value at the time of the NFT purchase is subject to capital gains tax. For instance, if you used 1 ETH, originally bought for $1,000, to purchase an NFT when ETH’s value was $2,500, you would owe taxes on the $1,500 gain. It’s worth mentioning that this is the case even if you use stablecoins such as USDT or USDC to purchase the NFT – disposing of a stablecoin is a taxable event, even if the gain or loss is minimal.

Staking rewards

Staking rewards allow investors to reinvest their earnings back into the same cryptocurrency ecosystem. When you receive staking rewards, the IRS treats them as ordinary income based on their fair market value at the time of receipt. If you decide to hold onto these rewards instead of selling them immediately, you're essentially reinvesting in the crypto market. This holding period can lead to capital gains or losses, depending on the market's performance. If you sell your staking rewards for more than their value when you received them, you’ll owe capital gains tax on the difference between the sale price and their cost basis, which is the income reported from the original staking reward.

Reinvesting between different asset classes

Reinvesting gains across different asset classes, such as shifting profits from crypto to stocks, real estate, or other investments, might seem like a smart way to diversify. However, much like reinvesting into another cryptocurrency or NFT, these transactions are generally considered taxable events. When you use crypto gains to purchase other assets like stocks or real estate, the IRS treats the sale of the original crypto investment as a taxable disposition, typically resulting in a capital gains tax liability.

That said, exceptions apply, such as when specific transactions are explicitly excluded from taxation by law or reinvesting occurs within a tax-advantaged retirement account, like a self-directed IRA. In these instances, taxes can be deferred according to the particular rules of the account. Outside these specific cases, any sales or exchanges involving appreciated investment assets will likely trigger a taxable event, even if you do not convert your crypto to fiat currency.

How do I report cryptocurrency reinvesting on my taxes?

Reporting cryptocurrency reinvestment on taxes involves documenting all taxable events, even when profits are immediately reinvested. Accurately completing these forms ensures proper reporting of cryptocurrency reinvestments on your taxes. Here’s an overview of the necessary documents:

Form 8949 (sales and other dispositions of capital assets)

Use Form 8949 to report all cryptocurrency disposals, including those from reinvestment activities. Here’s how to complete it:

1. List each transaction separately, including the date acquired, date sold, proceeds, cost basis, and gain or loss. 
2. Use separate forms for short-term and long-term capital gains.
3. Include a description of the property (e.g., "1 BTC" or "100 ETH").

Schedule D (Form 1040) 

Schedule D (Form 1040) summarizes total capital gains and losses from all sources, including cryptocurrency transactions. 

1. Transfer the totals from Form 8949 to the appropriate lines on Schedule D.
2. Calculate net short-term and long-term capital gains or losses, considering any unused capital loss carryovers from prior tax years.
3. Combine these figures to determine overall capital gain or loss for the tax year. If you have a net capital loss, you can use up to $3,000 to offset other taxable income (such as wages) while carrying over any excess losses to future tax years.

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.