Cryptocurrency can be a great way to make money and to explore the potentials of new forms of currency. However, people may be very unclear about how to handle their cryptocurrency holdings when it is time to file a tax return.
With the rise of Bitcoin, many people have sought to invest in these alternative currencies. As a result, governments and tax agencies have taken a much greater interest in tracking down cryptocurrency holders.
The IRS issued guidance on how cryptocurrency taxes should be dealt with. The agency has also issued a sheaf of warning letters to investors it believes have not complied with reporting requirements for cryptocurrency tax.
The Basics of Crypto Taxes
The IRS considers cryptocurrency to be a form of property, rather than currency, when it comes to assessing taxes. Whether you have Bitcoin or any of the alternative types of cryptocurrency such as Litecoin, Ethereum or Monero, the IRS treats them equally in terms of their tax status.
It is similar to owning gold, real estate, stocks and bonds or other types of property with high investment value and potential for fluctuation.
Much like gains from trading stocks, gains made through trading or cashing in cryptocurrency would be reported as capital gains and subject to the relevant tax.
If you fail to report sales and trades of cryptocurrencies, you may be vulnerable to an audit. The IRS considers non-reported cryptocurrency trading to be a form of tax fraud.
Calculating your Crypto Income
It is not difficult to calculate your cryptocurrency income accurately for reporting on your annual tax returns. One of the main things to understand is the difference between taxable events and non-taxable events.
Taxable Events vs. Non-Taxable Events
When something happens that makes you responsible for reporting it on your taxes, this is considered a taxable event. When it comes to cryptocurrency, taxable events are typically capital gains and capital losses. Here are some of the major taxable events for cryptocurrency investors:
- Trading in crypto holdings for U.S. dollars or other fiat currency
- Trading cryptocurrencies with one another (values should be calculated to USD at the time)
- Using crypto to pay for goods and services
- Earning income and being paid in cryptocurrency, or raising your crypto holdings through mining
Some other cryptocurrency events are non-taxable, however. Transferring crypto holdings between your own exchanges and wallets is not considered taxable. Buying cryptocurrency with your U.S. dollars is not taxable, and giving away your crypto holdings as a gift is a non-taxable event.
Determining Your Cost Basis
Now that you know which types of actions are subject to cryptocurrency taxes, you can prepare for the process to do so. After all, you pay taxes in U.S. currency rather than in Bitcoin or Ethereum, so you must calculate the cost basis of your holdings in U.S. dollars.
The cost basis reflects the purchase price of your holdings at the time you were buying cryptocurrency as well as other expenses that you accumulated through the purchase, including transaction and brokerage fees or exchange costs. To determine your cost basis, add the purchase price of your cryptocurrency to the fees involved, then divide by the quantity you purchased.
If you invested $400 in Monero in April 2019, you might have bought around 6.4 Monero. You may have paid your crypto exchange a transaction fee of about 1.49%. To calculate your cost basis, use the following formula:
($400 + 1.49%*400)/6.4 = $63.43 per Monero token
Subtract Cost Basis from Fair Market Value
If you sell any types of cryptocurrency, you will need to determine whether you have a capital gain or loss by subtracting the cost basis from the final sale price or fair market value. If you sold one Monero token a month later for $77, this would be a taxable event. You could calculate the gain by subtracting your cost basis from your fair market value.
$77 – $63.43 = $13.57 capital gains
By selling on the market at $77, this reflects the fair market value of Monero. To determine how much you made, you must consider how much you paid for the asset to begin with. You would owe a portion of this capital gain as part of your tax return. Of course, this becomes much more significant when multiplied tens or hundreds of times over.
What If You Lost Money Trading Cryptocurrency?
In some cases, your crypto trading may not have brought in money. You may have taken a capital loss on your crypto trading by selling crypto for less than your cost basis. You can use the same process to calculate your capital losses as your capital gains, and you may be entitled to a tax deduction as a result.
Many crypto traders may have a difficult time keeping track of the fair market value of your cryptocurrency investments and trades. In many cases, people have held cryptocurrencies for many years, and they may not have records of the cost basis or fair market value of their transactions. In particular, many of their trades may involve trading cryptocurrencies with one another, and they may not have clear records that reflect U.S. dollar value.
Many crypto holders have performed hundreds or thousands of crypto trades over time. In addition, cryptocurrency investors may have challenges accurately proving the fair market value and actual capital gains and losses associated with their trades over time.
How to File Those Taxes
To file your cryptocurrency taxes as part of your annual IRS tax return, you can use IRS form 8949 to document your transactions. The information from this form can be transferred to Form 1040 Schedule D. On Form 8949, you can record each transaction for the year. You will list the date of the sale or trade, the proceeds or fair market value, the cost basis and your resulting gain or loss.
You can add up all of your transactions on this form to gain a final number for capital gains and losses to report on Schedule D of your Form 1040. Both documents should be included as part of your tax return.
Getting Accurate Crypto Exchange Tax Reports
It can also be a challenge to get accurate reports from your cryptocurrency exchanges for proper tax filings. In many cases, crypto investors frequently transfer crypto from one exchange or wallet to another. The exchange may have no idea what the original cost basis of your crypto purchase was. If you transfer crypt in and out of an exchange, the exchange cannot accurately produce a report that reflects both your cost basis and your fair market value. Anyone who uses multiple exchanges or wallets is likely to have this problem.
Some cryptocurrency holders may opt to use additional tax software designed specifically for integrating reports from multiple exchanges and wallets and aggregating a cryptocurrency report. You can then report that information directly on your tax return, import it into tax software or provide it to your CPA or online accountant for further processing.
Getting Help On Those Taxes
Cryptocurrency tax reporting can be surprisingly complex, especially for people who are new to the world of investing. Because the IRS has taken such an interest in tracking cryptocurrency investments, you want to make sure your reports are accurate and correct. If you want help resolving questions about your crypto taxes, you can find professional assistance with the online accountants at Picnic Tax. We connect you with qualified accountants who can prepare your crypto taxes, including a wide range of complex factors. If you want to ensure that you have accurate returns with a professional touch while also handling everything online, Picnic Tax can help you.