Crypto Taxes: How to Calculate What You Owe to the IRS
The sweetest champagne can bring the heaviest hangover, and the biggest bargains often result in the heaviest tax burdens.
For anyone who has sold or traded dogecoin, ether, bitcoin or other cryptos in the past year, this tax season is going to be a headache. Cryptocurrencies are taxed as intangible assets, just like stocks or bonds. If you sell cryptocurrency, exchange it for another crypto, or even use it to buy something, you need to report the transaction to the IRS — and you could face a huge tax bill.
Some people might assume that the anonymous nature of cryptocurrency means that their activity would be invisible. Unfortunately for them, the Internal Revenue Service has X-Ray glasses.
Elliott Brack, managing director of tax services at Los Angeles Financial Advisory Manhattan West, said custom 1099 forms available for download on some crypto trading platforms are also provided to the IRS. Although crypto exchanges are not actually mandatory To report transactions to the IRS via 1099 forms through 2023, the agency also has other means of tax estimation.
“I just want to emphasize: yes, you do have to report your crypto transactions to the IRS,” said Blake Harris, an attorney who specializes in advising cryptocurrency owners on trusts and estates. “It is built on the blockchain, which keeps a permanent record of all transactions. If you don’t report, you risk getting caught.
The largely unregulated nature of crypto markets means that tax reporting has long been a user-generated activity. Crypto sites are improving their tax tracking data, but the reporting burden is still on the user.
Money has published a comprehensive guide to how crypto is taxed that you can check out, but the central question to address at tax time is simply: how much do I owe? To answer this, you need to be able to track the cost basis and determine how much you have earned in capital gains from trading crypto.
Crypto Taxes: How to Track the Cost Basis
The cost basis is the original price you paid for the asset. The IRS levies taxes based on the capital gain, which is the increase in price from the cost price to the price at the date of sale.
Traditionally, crypto trading sites haven’t been good at tracking the cost base, said Brack of Manhattan West, and it’s worth keeping your own set of records. Some crypto trading platforms, including Robinhood, have 1099 forms with estimated costs available for download if you sold crypto during the tax year, but this is a rare practice.
Coinbase provides an annual gain/loss estimate to users, but the company cautions that the data will only generate reliable cost-based information if all of your crypto trades have taken place on its exchange. If you moved your crypto wallet from another exchange, the Coinbase data does not take this into account. The same goes for trade tracking options on Binance.US.
It should be noted that none of these popular crypto exchanges currently send win/loss data to the IRS, so the numbers are unofficial. (Coinbase issues IRS forms to select customers, but only if they meet certain criteria aside from buying and selling basic crypto on the platform.)
Also, if you are trading on an automated, decentralized exchange like Uniswap or an overseas exchange, there are no 1099 or cost basis estimates of any kind, said Vik Sasi, Managing Director. digital assets at Manhattan West.
One website, CoinTracker.io, calculates the cost basis for people who have moved wallets or traded crypto across multiple exchanges. CoinTracker services range from $0 to $199 for most users, depending on how many transactions you need per year. Coinbase offers some of its users a discount for CoinTracker.
Depending on the type of tax software you use when filing, it might not be that hard to figure out how much you owe the IRS. TurboTax, for example, has partnerships with platforms like Coinbase and Robinhood that can automatically import thousands of crypto transactions at once.
If the IRS finds that you misreported your cost basis during an audit, it could mean you owe additional taxes. For this reason, it is essential to keep your own detailed records of the prices and times of crypto buying and selling.
If the records are confusing and there’s a lot of money at stake, it might be time to call in a professional accountant. For assets that have been gradually accumulated, a practitioner may value the cost basis using the more favorable “last in, first out” or “highest in, first out” methods than the default “first in, first out” method. released” enforced by the IRS, Brack said.
How to Reduce or Avoid Crypto Taxes
There are strategies to help minimize the amount you pay in cryptocurrency trading taxes, and not everyone who owns cryptocurrency will owe money.
The tax code rewards those who “HODL” — hold on for life — to their cryptocurrencies rather than sell them for quick and easy profits. One of the most fundamental factors in determining your tax burden is how long you’ve held the cryptocurrency, Nate Hansen, founder of online accounting firm SuperfastCPA, noted in an email.
If you sold the crypto after owning it for less than a year, you are subject to short-term capital gains taxes, which range from 22% to 37%. Long-term capital gains taxes are in the less painful range of 0% to 20%, depending on your income bracket.
“For investors who can hang in there and hold out for over a year and survive the dips, they can definitely provide a nice tax windfall when they sell,” said Brack, of Manhattan West.
One of the reasons the IRS treats generated income so differently is that short-term trading is considered an occupation, while holding is an investment.
Finally, while the IRS takes away, it also gives. If you experience a loss on one or more cryptocurrency investments and face a high tax bill for other reasons, you can tactically sell to offset the tax burden. It’s too late to do that for the 2021 tax year, but the strategy is worth considering towards the end of 2022.
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