Converting Cryptocurrency to a Stablecoin is Taxable (3 Scenarios)

Tax Accounting

Converting Cryptocurrency to a Stablecoin is Taxable (3 Scenarios)
Understanding the nuances of converting crypto to a stablecoin can make a big difference when it comes to your tax obligations. Which scenario are you in?
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Converting cryptocurrency to a stablecoin might appear a simple switcheroo in the world of ones and zeros, a mere flicker on the blockchain, but it also stands as a taxable event, a moment you can be sure Uncle Sam will be interested in. And by "interested," I mean want their cut.

Yes, the taxman cometh, even in the wild west of the crypto world, but it's not all gloom and doom.

Understanding the nuances of converting digital assets to stablecoins can make a world of difference when it comes to your tax obligations.

This guide will peel back the layers of this seemingly simple transaction, delve into real-world examples, and dissect the potential scenarios. Because, as we all know, nothing in crypto is as simple as it seems.

The tax implications of converting crypto to stablecoin

The IRS views crypto as property for tax purposes, akin to stocks or real estate​. So when you convert your crypto into a stablecoin, you essentially “dispose” of your crypto in the same way you might sell a stock or real estate holding. This disposal triggers a capital gains calculation. Simply put, if the value of your cryptocurrency has increased since you acquired it, you will have a capital gain. Conversely, if the value has decreased, you will have a capital loss.

Let's break it down further. Suppose you bought Bitcoin at $5,000 and its value has increased to $20,000 at the time you convert it into a stablecoin like USDT or USDC. You have a capital gain of $15,000. This gain is taxable and must be reported in your tax return. On the flip side, if the value of your Bitcoin has dropped to $3,000 when you make the conversion, you have a capital loss of $2,000. This loss can be used to offset other capital gains.

How taxes on capital gains or losses are calculated

The amount of tax owed is determined by two important factors: your tax bracket and the length of time the crypto was held before it was converted.

Crypto held for 365 days or less will be classified as short term and those held for more than 365 days will be classified as long term.

If the crypto you’re converting to a stablecoin was held for 365 or less and it increased in price since you bought it, you’ve incurred short term capital gains and the tax rate you pay is the same as your income tax rate.

2023 Tax Brackets
Tax Rate Single Head of Household Married Filing Jointly Married Filing Separately
10% $0 to $11,000 $0 to $15,700 $0 to $22,000 $0 to $11,000
12% $11,001 to $44,725 $15,701 to $59,850 $22,001 to $89,450 $11,001 to $44,725
22% $44,726 to $95,375 $59,851 to $95,350 $89,451 to $190,750 $44,726 to $95,375
24% $95,376 to $182,100 $95,351 to $182,100 $190,751 to $364,200 $95,376 to $182,100
32% $182,101 to $231,250 $182,101 to $231,250 $364,201 to $462,500 $182,101 to $231,250
35% $231,251 to $578,125 $231,251 to $578,100 $462,501 to $693,750 $231,251 to $346,875
37% $578,126 or more $578,101 or more $693,751 or more $346,876 or more

If you held for more than 365 days before converting, the tax rate for long term capital gains is taxed between 0% to 20% of the gains.

2023 Long-term Capital Gains Tax Table
Tax Rate Single Head of Household Married Filing Jointly Married Filing Separately
0% Up to $44,625 Up to $59,750 Up to $89,250 Up to $44,625
15% $44,626 – $492,300 $59,751 – $523,050 $89,251 – $553,850 $44,626 – $276,900
20% Over $492,300 Over $523,050 Over $553,850 Over $276,900

If it turns out that the crypto you converted to a stablecoin was worth less than what you paid for it, you have a capital loss. You won’t have to pay taxes, but should still report this to the IRS because it can reduce your overall tax bill. You can subtract your losses from your gains to shrink the total amount subject to capital gains tax.

The IRS will let you deduct up to $3,000 of capital losses (or up to $1,500 if you and your spouse are filing separate tax returns). If you have any leftover losses, you can carry the amount forward and claim it on a future tax return. Capital gains or losses should be reported on Form 8949.

Note that the period during which you held the crypto begins on the day after you acquired it and ends on the day you send it.

Next, let’s delve into a few hypothetical examples.

Example 1: Short-term Capital Gains

Let's say Alison falls into the 24% tax bracket. She bought 1 Bitcoin for $10,000 in January 2023 and decided to convert it to USDT when the price of Bitcoin reached $15,000 in June 2023, making a gain of $5,000. Because Alison held her Bitcoin for less than a year, this gain is considered a short-term capital gain and is taxed at her ordinary income tax rate, which is 24%. Therefore, Alison would owe $1,200 in taxes on this transaction ($5,000 * 24%).

Example 2: Long-term Capital Gains

On the other hand, let's consider Blake who is in the 32% tax bracket. Blake bought 1 Bitcoin for $10,000 in January 2022 and converted it to USDT when the price of Bitcoin reached $20,000 in February 2023, making a gain of $10,000. Because Blake held his Bitcoin for more than a year, this gain is considered a long-term capital gain. In the U.S., long-term capital gains are taxed at lower rates than ordinary income, typically at 0%, 15%, or 20%. Assuming Blake falls into the 15% category for long-term capital gains, he would owe $1,500 in taxes on this transaction ($10,000 * 15%).

Example 3: Capital Losses

Now consider Charlie in the 35% tax bracket. Charlie bought 1 Ethereum for $2,000 in March 2023 and due to market fluctuations, the value dropped to $1,500 in August 2023. Charlie decided to cut his losses and converted his Ethereum to DAI (another type of stablecoin). In this case, Charlie has a capital loss of $500. He can use this loss to offset other capital gains he may have. If he doesn't have any other gains, he can deduct the loss from his ordinary income, up to a limit of $3,000 per year, with the ability to carry over any remaining losses to future years.

Keep track of every crypto-to-stablecoin conversion

Every time you convert crypto to a stablecoin, you may be incurring capital gains or losses based on the fluctuation in the value of the crypto from the time you received it to the time you made the conversion. Each of these transactions can affect your tax liabilities, and keeping an accurate record of each one is not just sound financial advice, but a necessity.

That’s where crypto tax software like Bitwave comes in. Manual record-keeping can become a herculean task and Bitwave simplifies this process by automating the tracking of transactions, including conversions to stablecoins. It provides an efficient way to record, calculate, and report capital gains or losses from these transactions.

When it comes to managing your digital assets, arming yourself with the right tools is the first step towards financial prudence and peace of mind.

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Disclaimer: The information provided in this blog post is for general informational purposes only and should not be construed as tax, accounting, or financial advice. The content is not intended to address the specific needs of any individual or organization, and readers are encouraged to consult with a qualified tax, accounting, or financial professional before making any decisions based on the information provided. The author and the publisher of this blog post disclaim any liability, loss, or risk incurred as a consequence, directly or indirectly, of the use or application of any of the contents herein.