Crypto and Taxes — The Basics Part 1

Below is Part 1 of 3 on how to file your cryptocurrency taxes.

Part 1 will go over the basics of creating a capital gains/loss report. We will touch on things like cost basis, 1099B, etc.

Part 2 will go into “How do I know if I need to pay taxes”. We will go over use cases such as buying altcoins, mining, donating, etc.

Part 3 will go into some of the tools / services out there to help you calculate the reports.

Disclaimer: This isn’t tax advice, nor does it replace hiring a CPA. This information is based on personal experience, filing my own taxes, and talking with friends/CPAs on how they filed theirs.

Tax season is almost over. If you are like me, you probably waited until the last minute to do your taxes. You received a ton of forms from ranging from the state department to your employer. One thing you noticed (or didn’t notice), is you didn’t receive any tax forms for any of the cryptocurrencies you invested in last year.

The Basics

The IRS has deemed cryptocurrencies as “intangible property”. This means cryptocurrencies are traded similar to stocks (such as Apple, Google, etc). For tax purposes, this means you report capital gains/losses.

Easy right? Unfortunately, no. Normally when you buy or sell stocks you get forms, plug those in or give them to a CPA and you are done.

src: https://smartereum.com/wp-content/uploads/2018/02/coinbase-irs-cryptocurrency-810x405.png

Where are my forms?

If you sold normal stocks last year, you may have noticed that you received a 1099B from the institution (Robinhood, E-trade, Morgan Stanley etc). These insitutions are required by law to send you this form. It has information on when you purchased your stock, when you sold it, how much profit/loss you made, etc. Cryptocurrency exchanges are not required to send you this information and guess what, they didn’t. So here we are, with vague IRS rules and not a lot of help from the institutions themselves. Let’s talk about calculating your own capital gains/loss report.

Schedule D form img src: https://www.form8949.com/images/2017/png/f1040sd.1.png

Calculating your own capital gains/loss report

There are a few important things you need to know when you are self-reporting uncovered capital gains/loss (which is what you are doing).

First, you will be filing a Schedule D (hopefully you are using software) and second you will be filing a Form 8949 (again hopefully you are using software/CPA).

Second, you will need the following information:

• Description (Normally, just the name of the cryptocurrency)
• Purchase date.
• Purchase price (cost basis).
• Sale date.
• Sale amount (Proceeds).

Example of Form 8949 filled out img src: cointracker.io

Cost Basis and Cost Basis Method

This deserves its own section because it can get pretty complicated. As stated above, the cost basis is normally the purchase price. The cost basis gets when you want to sell the cryptocurrency. Let’s say for example you bought 1 Apple stock in September and 1 Apple stock in November. You then sold 1 Apple stock in December. How do you determine the purchase price of the stock you sold? Is it the one from September or November? Note: It gets even more complicated with cryptocurrencies because you can sell them in fractions (i.e. sell 0.1243 Bitcoins).

This is where cost basis methods come into play. The following are the most common cost basis methods:

• FIFO (First In First Out) — This one is straight forward. The first one you bought, is the first one you sell. In the above example, you would have sold the September stock.
• LIFO (Last In First Out) — The one is also pretty straight forward. The last one you bought, is the first one you sell. In the above example, you would have sold the November stock.
• HIFO (Highest Cost In First Out) — This one is calculated based on the highest cost basis. Sell the one with the highest cost basis is the most “efficient” tax strategy.

So which can I use for cryptocurrencies. Unfortunately, the answer is “it depends”. In most cases, you should use FIFO (even if it isn’t the most tax efficient). There are rules in the IRS publications that can determine if you qualify for LIFO and HIFO, but it is vague and the community isn’t convinced that one would qualify for it with cryptocurrencies. If you are self preparing, I recommend using FIFO (in case you get audited, it is the easiest to defend).

img src: https://encrypted-tbn0.gstatic.com/images?q=tbn:ANd9GcQYVuKljieS51rsELyzLg6dLEa4GJvcJG_Fh6VsDf2H9fVP0O66

Long Term and Short Term sales

A long term sale is when you held an asset for more than 1 year and 1 day.

A short term sale is when you held an asset for less than 1 year.

The cost basis method needs to be taken into account to determine which asset is being sold.

Recording every transaction

A question about recording every transaction comes up every now and then.

Do you need to record every transaction? Yes. Even if this is complicated to do, I highly recommend it in case you get audited.

Do you need to report every transaction on the form? Maybe. If you only have a few trades, you should record all of them.

If you have hundreds, you may be okay to just record one transaction as “Digital Assets” or “Cryptocurrencies” or “Virtual assets” and sum up the cost basis and proceeds of all your trades. As for purchasing date, and sale date, you can put the first date you purchased and the last date you sold in the year. Note: As stated above, this isn’t tax advice, you may want to consult a CPA.

If you do bundle, make sure you bundle all the short term sales and long term sales separately.

Whew. We made it. Next we will talk about specific situations that trigger taxable events in Part 2.