According to a report from the Journal of Accountancy, in 2015 only 900 taxpayers reported their cryptocurrency gains to the IRS. At the same time, the popular exchange Coinbase was boasting over 5.9 million users.
This massive numbers gap sparked the IRS into action and it is believed that they are now actively targeting cryptocurrency owners with audits. Because of this, you may be more likely now to get into trouble over unreported crypto earnings than other issues on your tax return.
This is why, in this trader’s guide, we are going to walk you through the ins-and-outs of reporting your crypto earnings accurately.
You need to get tax-savvy with your cryptocurrency investments and transactions. If you are using or holding virtual currencies, it is vital that you understand how to accurately report your gains—otherwise, you might find yourself in hot water.
Fortunately, we are here to help. The goal of this trader’s guide is to help illuminate and untangle some of the complexities related to cryptocurrency taxes. Read on to learn exactly how to be IRS compliant with your crypto earnings.
Understand How Cryptocurrencies Are Taxed
For now, the IRS categorizes cryptocurrency gains and losses as capital gains/losses.
This means that you will be taxed on them just as you would be taxed on other capital gains.
Cryptocurrency assets held for longer than a year are deemed to be long-term capital gains and are taxed like other capital gains.
Crypto assets that are held for under a year and then sold fall into the category of short-term capital gains. These are taxed at the regular tax rate. The exact rate at which you will be taxed is determined by your tax bracket.
There is one exception to the capital gains rule, and that is mining.
According to the IRS, net income derived from mining (gains minus expenses) is deemed as personal income and attracts personal income tax.
Get Clear on What Crypto Transactions Are Taxable
The next step in our trader’s guide is to walk through figuring out how to file taxes correctly on cryptocurrency, and to understand what transactions attract tax reporting responsibilities.
These are generally transactions that attract a gain for you.
They are called taxable events, and include:
- The selling of any cryptocurrency for fiat currency
- The selling of any cryptocurrency for another cryptocurrency
- Paying with cryptocurrency for goods or services (as this might attract a gain depending on the price at which you bought the crypto)
- The earning of cryptocurrencies as a salary, wage, for mining, or for goods or services rendered
Besides these taxable events, there are also a couple of non-taxable events that do not attract any tax or reporting responsibility. These are:
- Buying cryptocurrency with fiat currency
- Gifting cryptocurrency
- Transferring cryptocurrency from one wallet or account to another
Even though all crypto transactions aren’t taxable, you will still need to keep track of them all, otherwise, you might not be able to record your gains or losses accurately.
Let’s take a look at how to do this.
Record Your Gains Accurately
To work out your cryptocurrency gains (or losses) for the year, you need to work out the profit (or loss) on each cryptocurrency transaction that you make.
For example, say you bought bitcoin in November 2016, at which point you would have paid roughly $700 for it. Then, towards the end of last year, you sold some.
Depending on the exact time you sold, the price of bitcoin would have been around $7,000.
For simplicity’s sake, let’s say you struck it lucky and you had an entire bitcoin to sell. In this case, you would calculate your gain as follows:
$7,000 – $700 = $6,300
Sale value – Cost price = Profit
Of course, in real life, the math isn’t always so easy. Also, the more trades/transactions you do, the trickier it can be to keep track of the exact profit that each one attracts.
Finally, don’t forget that any purchases of goods or services that you make with crypto also need to be recorded, and the gain or loss that they attracted worked out and reported.
For example, if you buy a cup of coffee with bitcoin that you bought before the pump, you will definitely attract a gain on it when you pay for your coffee because the bitcoin is now worth a lot more.
To work out the gain, you need to apply the above formula and calculate the dollar amount of profit that you made by selling the bitcoin in exchange for a cup of coffee.
All this can get pretty complicated, but it is essential that you are diligent and record all your transactions and the profit or loss they incur. Not doing so is fraudulent, as it means that you won’t be able to make out an accurate tax return.
Subtract Your Tax Deductible Expenses
There is some good news, however. You can deduct any applicable expenses to offset your crypto tax liability.
Deductible expenses include:
- Exchange fees
- Wallet fees
- Transaction fees
- Trading losses
Be sure to keep a tally of these so that you can include them in your tax return and lower any potential tax liability.
Top tip: Did you make a loss in crypto within the last tax year? If so, you can use this to offset any other capital gains you might have incurred in the last tax year, such as selling a property.
File Your Return
Once you have all your figures in a row it’s time to fill out and file your return, the last topic of our cryptocurrency taxes trader’s guide.
For this, you will need the IRS form 8949 and a 1040 Schedule D.
On form 8949 you need to declare all taxable crypto events that you engaged in for the financial year, including the dates, sales amounts, base costs (the price at which you bought at), and attracted gains or losses.
Then calculate the total gain or loss for the year, and transfer this to the 1040 Schedule D form. (This declares your total capital gain or capital loss.)
Still Not Confident About Calculating Your Tax After Reading This Trader’s Guide?
Being tax compliant with cryptocurrencies is not all that easy, as it involved a lot of record-keeping, some of which is very difficult if done in hindsight.
If you are still not 100% confident about your cryptocurrency taxes after reading this trader’s guide, contact us today to find out more about your options.