Two things in crypto are certain: getting rekt and paying taxes. If you trade crypto, you will get rekt at some point. If you somehow manage to avoid getting rekt, you will have to pay taxes on those gains, especially if you live in the United States. because another thing you can bank on is Uncle Sam paying you a visit if you neglect to pay your bill.
Tax codes, structures, and laws are already difficult enough to understand without crypto involved, which is likely why tax prep services are an almost 12-billion-dollar-a-year industry.
To help, we've composed a comprehensive guide to cryptocurrency taxes.
The Internal Revenue Service (IRS) in the United States treats crypto coins and tokens like Bitcoin, Eth, and USDT as property instead of currency for the purpose of federal taxes, meaning that trading or selling cryptocurrency is a taxable event and you may be subject to capital gains tax. You must report your transactions to the IRS, regardless of whether you made a profit or suffered a loss.
Tips for Doing Cryptocurrency Taxes
This guide will discuss what to do to prepare for the dreaded tax season. We will review how to keep records of your transactions, talk high-level about calculating capital gains or losses, and then look at a few helpful crypto-specific tax services that can help you stay above water, pay your bill, and get back to doing what you enjoy most: rolling your 401K and your kids’ 529 College Choice plan into your favorite frog-themed memecoin.
Taxes From Crypto Trades on Centralized Exchanges
Recording Your Transactions
Tax laws and regulations related to cryptocurrencies may vary by country, and there can be additional legislation to navigate at the State, Provincial, or Municipal level, so understanding the laws in your area is imperative. While we hope to provide some value and insight, we are not tax professionals, attorneys, fiduciaries, accountants, or financial advisors. If you are concerned about your situation, consulting a licensed professional to help you is recommended.
Keep explicit and detailed records of all your cryptocurrency transactions. These records should include the date, amount, purpose, and value in your local currency at the time of the transaction. Keeping accurate records of your cryptocurrency transactions is essential for tax purposes, especially if you are ever subject to an audit, and it can be helpful to have a system in place for tracking these transactions throughout the year. Below are a few common strategies to help you stay ahead of the game.
Use Exchange Reports: Many cryptocurrency exchanges provide downloadable transaction histories. These can be a great starting point for your record-keeping. Make it a habit to download these reports regularly.
Use a Dedicated Spreadsheet: You can use a spreadsheet to track your transactions. Include columns for the date, the cryptocurrency bought or sold, the amount, the price in your local currency, and any fees. Update this spreadsheet after each transaction. Keeping a separate spreadsheet is especially helpful if you do most of your trading on DEXs. You can get your transaction records directly from the block explorer. However, you should note the price of traded assets at the time of the transaction might be necessary if your basis for swapping is anything besides stablecoin.
Automated Tracking with Software: Tax software like Koinly and CoinLedger can automatically track your transactions from various exchanges and wallets, significantly reducing the burden of manual record-keeping.
Use Wallet Transaction Histories: If you use a non-custodial wallet, you can often export your transaction history, which you can include with your records.
Regularly Update Your Records: Instead of leaving all the record-keeping until the end of the year, try to update your records regularly, such as weekly or monthly can spread the burden of record-keeping and ensure that you remember significant details.
Maintain Records for Each Crypto Asset: If you deal with multiple cryptocurrencies, you should maintain separate records for every crypto you trade. Cryptocurrencies may have different tax implications, so keeping separate records can make your tax calculations more accurate.
Record Hard Forks, Airdrops, and Rewards: If you receive new cryptocurrencies from hard forks, airdrops, or staking rewards, you should record them as they may be taxable.
Keep Records of Any Losses: If, for example, you lose access to your coins or tokens through theft or a lost private key, be sure to record this event since it could constitute a capital loss.
Remember, the key to good record-keeping is consistency. Make it a habit to record your transactions along the way. Keeping good records will make the process of filing your taxes easier.
Many exchanges like Coinbase and Binance have helpful resources that keep detailed records for tax reporting. However, if you trade within a non-custodial wallet, you may need to track your own profit and loss.
Record the value of the crypto at the time of the trade - this will be your cost basis. When you later sell or trade that crypto, the value at that time minus the cost basis is your capital gain or loss. We cover this in the next section.
Calculating Capital Gains or Losses
A capital gain or loss in cryptocurrency is the difference between the cost basis (what you paid for the coin or token, including fees) and the price at which you sold it. If the selling price supersedes the cost basis, you have experienced a capital gain. If it is lower, it constitutes a capital loss.
Capital gains or losses happen when you "dispose" of your cryptocurrency. The term disposal includes the sale of your coins for fiat currency, exchange for another cryptocurrency, purchase of goods or services, or giving it away.
Methodologies for Calculating Your Profit and Loss
There are several methodologies for calculating capital gains or losses, including First-In-First-Out (FIFO), Last-In-First-Out (LIFO), and Specific Identification (SpecID).
FIFO: This method assumes that the first assets bought are the first sold. In a rising market, FIFO tends to result in higher capital gains (and therefore higher taxes) because it assumes the oldest (and likely cheapest) assets get sold first.
LIFO: This method assumes that the last assets purchased are the first ones you sell. In a rising market, LIFO tends to result in lower capital gains because the newest (and likely most expensive) assets are the first ones sold.
SpecID: This method allows you to identify which specific assets you sell. This strategy can minimize your capital gains if you strategically choose to sell assets with a higher cost basis first. However, it requires meticulous record-keeping.
The method you choose can significantly impact your tax liability. The IRS has not given specific guidance on which to use for cryptocurrency, but once you select a strategy, you should use it consistently.
Short-Term vs. Long-Term Capital Gains
In the United States, capital gains are classified either as either short-term or long-term:
Short-term capital gains are from assets held for one year or less. They are taxed at your regular income tax rate.
Long-term capital gains are from assets held for more than one year. They are taxed at a reduced rate, which can be 0%, 15%, or 20%, depending on your taxable income.
Capital Losses
A capital loss occurs when you sell or dispose of a cryptocurrency for less than its cost basis. You can use capital losses to offset capital gains and reduce tax liability. If your capital losses exceed your capital gains, you can use the loss to offset up to $3,000 of other income. The loss can be carried forward to future tax years if you record more than $3,000 in losses.
Use Tax Software to Help with Crypto Taxes
Given the complexity of cryptocurrency tax reporting, there are several tax software solutions that can help streamline the process. Crypto tax software can also alleviate some of the burdens of record keeping by tracking your transactions for you and making the necessary calculations after a trade. Below are a few notable cryptocurrency tax software solutions.
TokenTax: TokenTax provides tax-reporting services and supports a wide range of exchanges. It has tools for calculating crypto taxes and generating tax forms.
ZenLedger: ZenLedger allows you to import cryptocurrency transactions, calculate gains and income, and auto-fill tax forms like 8949 & Schedule D.
Koinly: Koinly is a crypto tax software that automates tax reports and offers a tax calculator. It is known for its portfolio tracking and tax reporting features.
Accointing: Accointing is a tax app that caters to novice crypto traders and offers helpful features to solve tax problems. It is known for its user-friendly interface and features.
You can check out our in-depth review of some of the best crypto tax software here for more information about available tools and resources to help you do your cryptocurrency taxes.
Reporting Earnings and Losses
In the US, Form 8949 and Schedule D report capital gains and losses from your cryptocurrency trades. Form 8949 is where you detail your trades, while Schedule D aggregates the total of your trades.
If you received cryptocurrency as payment for goods or services, this is considered income and must be reported. In this case, you would include it on your tax return like any other income.
If you live in the United States, you can find more information about cryptocurrency tax liability by visiting the official IRS website. If you are outside the United States, please review your local legislation to determine the necessary implications of cryptocurrency for taxes.
Taxes from Crypto Trades on Centralized Exchanges
Most centralized exchanges will provide a history of your transactions on their platform. Some cryptocurrency exchanges integrate directly with TurboTax and other tax software. If you use tax software designed for crypto, some solutions will integrate directly with your centralized exchange account to make the process easier.
It is important to note that a centralized exchange might not provide a complete tax report, so you should keep records of all your transactions for tax purposes. If the exchange is in the US, they may send a Form 1099-K or 1099-B to both you and the IRS if your trading activity is above a certain threshold.
Crypto Tax Filing Overview
Record Keeping: Keep records of all your transactions, including buys, sells, and trades between cryptocurrencies. It is essential to note the date of the transaction, the amount in cryptocurrency, the value in your local currency at the time of the transaction, and the fees.
Calculating Profits and Losses: Profits and losses are calculated by subtracting your cost basis (the original cost of the asset, plus any related expenses) from the sale price. Use the market value of the cryptocurrency in your local currency at the time of each transaction. These guidelines apply to all transactions, not just when you cash out to fiat. Manual calculations for non-custodial wallets might be necessary as most wallets will not provide this information (unless you have crypto tax software connected to your non-custodial wallet).
Reporting Earnings and Loss: In the United States, for example, earnings and losses get reported on IRS Form 8949 and Schedule D. You would need to specify the type of property, date acquired, date sold, proceeds (fair market value), cost basis, and gain or loss. Other forms for earnings and losses may also need to be retrieved, completed, or submitted.
Software Solutions: Software solutions can help calculate and report taxes on your cryptocurrency transactions. The available software solutions range from enterprise-grade and costly to inexpensive and beginner-friendly. You should evaluate your need and base your purchasing decision on the best solution for your use case.
Professional Help: If your tax situation is complex, consider enlisting the service of a tax professional familiar with cryptocurrency. They can ensure that you follow all applicable tax laws and help you optimize your tax strategy. It is better to pay a little for professional help than to deal with legal or tax consequences.
If you follow these steps and use the available tools and resources, you should be in a good place when tax time comes around.
Do Your Taxes.
Nobody likes doing taxes. It can be frustrating if you spent the entire year growing your bag to something worthwhile just to watch a substantial chunk of your earnings get eaten by the burden of short-term capital gains tax. The landscape for cryptocurrency taxes can also be confusing and difficult to navigate since every trade is a taxable event.
Set yourself up for success beforehand by keeping good records, finding the right software, completing the necessary forms, and setting aside some of your earnings to cover your tax bill. It's one thing when you get rekt on an NFT rug pull or memecoin presale. It’s a whole other thing to get rekt by the IRS. Be safe, have fun, keep good records, and pay taxes.