Price Moves Aren’t Taxes: The Realization Rule(s) for Digital Assets

Most modern digital assets behave like other capital assets for tax purposes: their value can rise or fall while you hold them, but those ups and downs are unrealized and not taxable until you dispose of the asset. Price movement alone does nothing to your current tax bill. A taxable event occurs only when you realize a gain or loss, typically by selling the asset for cash, swapping it for another asset, or spending it on goods or services. The IRS treats cryptocurrency, stablecoins, many NFTs, and virtual currency (mostly) as property (opposed to securities). When you hold them for investment or personal purposes, they are usually capital assets subject to the familiar realization framework.

Taxable Event - Since many digital assets are taxed under property rules, computing gain or loss follows a simple equation, amount realized minus adjusted basis. Your cost basis is usually what you paid in U.S. dollars plus transaction fees. If you acquired tokens in a way that produced ordinary income when received (certain airdrops or tokens received in exchange for services), the fair market value at receipt becomes your cost basis going forward.

Holding Periods - Your holding period starts the day after you acquire a unit and ends on the day you dispose of it. If you hold for one year or less, any gain or loss is short-term capital and taxed at ordinary rates. Depending on your tax bracket and state of domicile this could be near (or over!) 50% effective tax rate. Holding for longer than one year and it becomes long-term capital gain which is eligible for preferential capital-gain rates. The holding-period clock is lot-specific, so if you sell part of a position, the specific units (or “lots”) you dispose of will drive whether your result is short- or long-term.

Wash-Sales - A frequent misconception is that digital-asset swaps can be deferred under like-kind exchange rules. They cannot. Since 2018, IRC §1031 has been limited to real property (real estate). Exchanging one token for another is a taxable event in the year of the swap. Many investors ask us about wash-sales, specifically losses. The federal wash-sale rule in §1091 disallows certain losses if you sell stock or securities at a loss and buy substantially identical stock or securities within 30 days before or after the sale. Most digital assets are not “stock or securities” for this purpose, so §1091 does not currently disallow typical crypto losses. That said, anti-abuse doctrines (like economic substance) still apply, and instruments that are securities, like tokenized equity, can implicate the rule.

There is tax planning in all of this. Using digital assets as payments to employees or contractors can help conserve cash. Selling cryptocurrency when it’s advantageous for the company treasury takes patience and timing. Navigating the capital loss limitations and carryforward rules are imperative to planning taxable income and potential cash tax. Contact us today and let us help you plan your next steps.