Crypto and Taxes
An unofficial guide to crypto currency and US taxes
I’ve been gathering information about crypto and taxes to help me understand the landscape. I just recently listened to some good podcasts as well that had good info about nuances between crypto and the IRS. Being that I just personally filed my taxes the other day, I thought some of the information I’ve stumbled across might be useful to you. I’ll be updating this from time to time as I gather more information.
Obligatory: Please note that this is not economic advice. As always, do your own research and seek professional guidance when doing your taxes.
To first clarify what is meant by spending crypto, it is a tax event that may generate capital gains or losses, which could be short, or long-term. Converting a cryptocurrency to U.S. dollars or trading for another currency is also taxable. It is treated as being “sold”, and therefore generates capital gains.
Personally, I’m of the mindset that it’s easier to just report everything and avoid any headaches down the road. Of course, there are ways to evade being tracked, and some of the underlying DNA for crypto is based upon anonymity, but I’d prefer to come clean, pay, and simply not worry about it.
IRS and Crypto
The first thing you need to know is that, for tax purposes, the IRS treats crypto as property and not currency. Sales are subject to capital gains taxes like stocks or bonds. Form 8949 needs to be filled out for all trades. Here is the notice that explains it:
https://www.irs.gov/pub/irs-drop/n-14-21.pdf
Crypto Payments and Mining
The IRS document mentioned above also comments on mining, which is includable in gross income. This is the same with getting paid for services or receiving crypto as a contractor or an employee of a company. It’s obvious that the definition for crypto currency is very loose and the IRS is trying to get their hands around the concept.
Like-Kind Exchanges
Cryptocurrency trading is not considered like-kind exchanges, which are submitted on form 1031. A like-kind exchange is when you sell a house and use the gains to buy another house. You’re basically deferring your gains. However, in the event that you do file a 1031, you need a qualified intermediary that is handling the sale, the buy, and all the details of the transaction. If you sell the second property, you’ll pay capital gains on anything above your basis on the original investment. The interesting thing is that the IRS just ruled that 1031 exchange can only be used for real-estate for 2018 and going forward. The IRS looks at crypto the way it looks at stocks where you can’t defer gains. Same for commodities — if you trade gold for silver you pay capital gains. For crypto, this means that every time you trade, you need to realize a gain or a loss. Additionally, making a like-kind exchange argument would be difficult because establishing a qualified intermediary to detail the funds from purchase to purchase is not available. This also means that if you purchase your coffee or weed with crypto, you have technically created a tax event and it needs to be reported on form 8949.
Wash Sale Rules
Wash-Sale rules are defined in section 1091 of the tax code. According to Investopedia, the IRS defines a wash sale rule as follows:
“The rule defines a wash sale as one that occurs when an individual sells or trades a security at a loss, and within 30 days before or after this sale, buys a “substantially identical” stock or security, or acquires a contract or option to do so. A wash sale also results if an individual sells a security, and the spouse or a company controlled by the individual buys a substantially equivalent security.”
At the moment, wash-sale rules only apply to “shares of stocks or securities”. However, the IRS can come after the transaction for economic substance if you actually do this with a large amount of crypto. I did hear of a few people sitting out in January and buying back in February after selling in December. Proceed with caution.
Legislation
With regards to legislation, there’s a de minimus tax requirement that some congress folks are trying to introduce. This would exempt anybody with transactions under $600 and would be particularly beneficial for holders. It’s been stalled a few times — we need to support the Blockchain Caucus in Congress. See here:
https://www.congressionalblockchaincaucus.com
Wallet Transfer
There’s a lot of tax tools out there, such as Bitcoin.tax and Cointracking.info. Watch out for wallet transfers. These are typically considered sales on these tools. You need to go in and specify that you were moving from one wallet to another. This also applies when you go from Coinbase to Binance. Coinbase will display this as a sale and you would be taxed on this if you don’t clarify you’re moving it within your wallets. _Review all transactions before going to your tax accountant!_
Forks
If you have a coin that forks and receive coins as a result. You will also have to pay taxes on those new coins. When you go and trade those coins, it will be a taxable event and the basis for this is usually $0, meaning that you will have to pay for the taxes on the entire value when you trade them. It’s possible to split the basis of the original coin that forked, but that gets super complicated so it’s easier to assume that the basis price is $0 — especially in the event that you sell relatively soon after receiving.
ICO Tokens / Airdrops
Many people purchase tokens during an ICO and it can be unclear as to what to do with these coins. The first thing to know, for tax purposes, is that the date of the buy is technically the date that they were received. Receiving the tokens is not a taxable event. It is only when you sell them for fiat or another currency that a taxable event takes place. When this happens, you pay taxes on the difference between what you paid and the value at the time of the trade.
Interest for Staking
Some people will receive interest on their purchases. In the event that you received interest for staking a coin, you would need to report that income. There is a line on form 1040 for income from dividends. It’s pretty simple reporting.
Short Term vs. Long Term Capital Gains
Short term capital gains are anything you owned for under 1 year. Long term is anything you’ve owned for longer than a year. The difference will be the tax rate. Short term is tax at your ordinary individual income tax rate, which is calculated based on all your income including jobs, investments, business, and crypto gains. This can be anywhere from 0% to 39.6%. Long term is taxed at anywhere between 0% to 20%. This also applies to ex-pats or students living abroad!
Losses
I know we’re all amazing traders, but sometimes we need to take some small losses (but not more than 49% of the time). If this does happen, you can claim a loss to offset your gains. The maximum amount you can claim as a loss in a year is $3,000. So if you lost $4,000, you would take $3,000 in year 1, and $1,000 in year 2. Losses can carry forward to following years. You have to be careful with this because if you had huge gains via your sales, then your coin loses a ton of value (like many did at the end of December and January), you’re still on the hook for what you owed prior to your coin losing. I think that this is particularly important if you’re trading — always take some profits.
LIFO vs FIFO
My accountant is just treating all trades as gains/losses using form 8949 detailing each of these items. You can do this easily with Bitcoin.tax or Cointracking.info. This brings me to the next point — how to report trades and realized gains and losses. Some people use FIFO and others use LIFO. The most advantageous to a day-trader could be LIFO, assuming you always leave a little something in the wallet that never leaves, you can potentially get a lower tax rate if it’s held over a year. However, it’s recommended that you go the LIFO route because the only exception (for stocks) is where there is ‘adequate identification’. This is a complicated topic, but you can get more info via the link below. Though, keep in mind that when you choose one, you need to use it for all your trade reporting.
https://bravenewcoin.com/news/capital-gains-on-cryptocurrency-fifo-lifo-or-specific-identification/
One of the tough things regarding reporting your trades in a specific way is that the burden is on the tax payer to report detail out the records of trading and prices at the time of trades. This is easier for coins like BTC, LTC, ETH that are paired to USD(T) but all other tokens are trickier and you’ll need to take an average daily price for this.
Estimated Taxes
If you do regular day trading and making a lot of money along the way, you’re required to pay estimated taxes. If you don’t, you will receive a tax bill that will also include interest for the year. Regular traders are supposed to pay this quarterly. The reason for this is that the US has a pay as you earn system. In regular jobs, your taxes are withheld weekly, bi-weekly, monthly, etc based on how frequently you get paid. While you’re day trading, if your tax liability is more than $1000 you should be making quarterly payments. Otherwise you can make annual payments. When you do need to make quarterly payments, you need to make sure you’re not underpaying by too much because you’ll own interest. People will often overpay a bit then correct it at the end of the year. Here is more information:
https://www.irs.gov/publications/p505
Also keep in mind that these are self-employment wages. When you pay self-employment tax, you also need to pay for medicare and social security. This will increase those tax rates considerably (7–10%). The good thing is that you can take half of that amount and offset your taxable wages.
Gifting Tokens
You can gift your tokens to another person, like your brother. The great thing about this is that it is not a taxable event. Your brother takes the coins and doesn’t have to pay anything. However, when the coins are sold, your brother would need to pay taxes and most importantly the basis transfers from the original purchase you made. The basis is not calculated from the date of gift!
Let’s say you purchased a coin for $1 and gave it to your brother. He holds it for a year and then it’s worth $10 and he sells it. You wouldn’t need to pay taxes when you gave it to your brother but your brother would need to pay taxes on $9 difference because the basis carried over from your original purchase.
Buying for Friends
Many of you may have purchased coins on behalf of your friends or family. Keep in mind that when this happens, you are the one on record purchasing and trading these coins. This means you’ll be on the hook for the taxes so be careful with doing this. You’ll need to keep proper records if you’re doing anything or gifting anything to friends.
That’s about all I know right now. I hope you’ve found this helpful. I’ll keep updating it from time-to-time as I find more information.
