June 9, 2022
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Cryptocurrency is used as an investment, to conduct secure transactions online and, increasingly, to pay and be paid for goods and services. Each country has its own rules on its use and, given how relatively new cryptocurrency is, these laws are still evolving. Some countries don’t allow the use of cryptocurrency at all. But how do you report these transactions for tax purposes?
Well, that is going to differ depending on where you live, so this post will concentrate on how it works in the USA.
Do you Need to Report Cryptocurrency to the IRS?
Yes, unfortunately, you have to report your cryptocurrency holdings to the IRS. The IRS is now actively investigating cryptocurrency transactions to ensure that people are paying the relevant taxes. The IRS treats cryptocurrency as an asset, in much the same way as real estate property or stocks and shares. This means that you have to report any increase or decrease in the value of any cryptocurrency you hold during the tax period as capital gains, profits and losses.
How this is assessed depends on how long you hold an asset. If you sell an asset within a year of purchase, this is treated as a short-term capital gains profit or loss. On the other hand, if you sell after a longer period than this, it’s classed as long-term capital gain or loss. These different categories come with different rates and thresholds.
Reporting Cryptocurrency Trades on Your Tax Return
Purchasing Cryptocurrency in Dollars
If you buy cryptocurrency in dollars and hold it in your exchange for the duration of the tax years, you would not be liable for any tax on it. If this is your only activity in crypto trading, you don’t need to report it to the IRS at all.
Making Cryptocurrency Trades
As soon as you trade your cryptocurrency tokens for a fiat currency or another cryptocurrency, or even use it to purchase goods or services, this becomes a taxable action in the eyes of the IRS. You will have to calculate the value of the asset (the cryptocurrency tokens) when you bought or acquired it, compare it to the value when you traded it and calculate the difference as a profit or loss.
For example, if you bought $500 of Ethereum and sold it or traded it when its value was $1000, you are liable for taxes on the capital gain of $500, subject to capital gains thresholds and whether it was a short- or long-term transaction.
Reporting Crypto Income
Perhaps you are running a business where you are paid in Ethereum for goods or services, or maybe you are mining Bitcoin. This will need to be reported as income, based on the price of the tokens when you received them. There are also ways of earning cryptocurrency through activities on the blockchain or as rewards for using an exchange platform. These are all taxable.
The main implication of this is that, as well as recording this income, you need to record how much it was worth at the time you received it, at what the IRS terms as “fair market value.” This can, of course, be a complex task for any individual or business. To complicate things further, if you use the crypto you received to pay for something else, you also need to record its fair market value at the time this transaction took place.
Track Every Transaction
The key to keeping on top of your reporting head of submitting your tax return is to keep detailed records of every transaction. Some cryptocurrency exchanges help with this by issuing a Form 1099-B, which will help you track your profits and losses. Although this is not particularly common as yet, they will be required to do so from the 2023 tax year. This is because of a provision of the 2021 infrastructure bill signed into law by President Biden in November 2021. Basically, cryptocurrency exchanges will then be required by law to report all cryptocurrency transactions to the IRS directly.
This will be helpful if you keep most of your transactions within one exchange, but it is still your responsibility to report everything. For example, if you move your tokens between private wallets, you need to remember to report that too.
Software packages are emerging that help with this and many are also compatible with tax reporting packages like TurboTax and TaxAct, CoinTracker, TokenTax and CryptoTrader.
Prepare for Tax Season
If you only have a few cryptocurrency transactions to record, it’s not hard to do it as you normally would in time for the tax season. However, if you’ve been making a lot of trades or most of your income is via cryptocurrency transactions, it’s a bad idea to leave it until April 1st to sort out a year’s worth of records.
Plan to update your records on at least a monthly basis to spread the burden. This also gives you more time to check for inaccuracies. The last thing anyone needs is a fine from the IRS for a reporting error that could have been easily rectified with more preparation.
Get Help from a Professional
Tax reporting is a minefield for the unwary and you can easily find yourself overwhelmed. If you’re reporting a lot of transactions, it’s worth getting a tax professional involved. Even if you’re only dabbling, it could still be worth getting some one-off advice from someone with expertise in this area.
Of course, not all tax professionals are well-versed in the tax implications of cryptocurrency transactions; it’s best to do your homework to ensure you find the right person for the job. You need to look for a tax professional who knows the latest IRS guidance and is experienced in reporting crypto gains and losses. When looking for the right advice, you might also want to ask if they have any personal cryptocurrency investments. There are still many gray areas in the tax code when it comes to crypto trading and transactions, so you also need your advisor to acknowledge this.
Finally, although all of this seems extremely complicated, don’t let it put you off from investing in and using cryptocurrency. There are significant advantages to its use and potentially huge earnings to be made, and tax regulations are sure to become simpler to navigate as the adoption of cryptocurrency becomes more commonplace.