Cryptocurrency and Taxes
From a technical perspective cryptocurrency is very easy to trade. Sign up to an exchange, deposit some fiat currency, and with just a couple of clicks one can become the new owner of some Bitcoin, Ethereum, or another coin that has taken the world of digital investments by storm. But while cryptocurrency may be easy to acquire, did you know it’s a terrible headache to deal with tax-wise?
It’s true! And this applies especially to cryptocurrency transactions you make frequently. Whether buying, selling, or exchange (trading one crypto for another), when investing in crypto beyond there are a number of factors you really need to keep in mind, especially with the IRS’s new interest in it.
Cryptocurrency is treated as property. This means any profits you make are treated as a capital gain. While your currency may be innovative and digital, the IRS approach to it is historic and old school. You made money from the growth of value in a financial asset, and upon such time as the value of the asset is realized, the government will expect a cut of the profit.
Following the explosion of interest in crypto trading during the last year (and especially in Bitcoin) it’s safe to say the IRS is paying special attention to tax returns with crypto declarations. This field has been in the spotlight for a couple of years now, but now crypto trading has well and truly shifted from a niche pursuit to a mainstream activity, Washington recognizes a consistent and universal approach to cryptos is a must.
And this may not make a keen crypto trader happy, as every transaction is regarded as a taxable event.
At present time it is expected any crypto trader will keep a record not only of the transactions that saw their crypto investment realized (sold to the market in return for fiat currency), but also every transaction that occurs along the way that produces a change in value.
So, even if you are a daily crypto trader who changes a position a dozen times every hour, the expectation remains you will keep track of every change in value. For example:
- If you invest $100 into buying an amount of crypto coin X,
- Then trade X for an amount of crypto coin Y
- Then see Y skyrocket in value
- And so use the gain you’ve sustained in Y to rebuy a higher amount of X
- Then cash out X’s higher value (say for $200, and $100 above your original investment)
…then the IRS will expect you to maintain a record of each transaction, including the value of each currency at the time of the transaction.
Any reader who trades stocks as well as cryptos will recognize this process is laborious, but seemingly not that different from trading stocks, right? Wrong! While the processes are similar, the difference here is stocks traded on a US market via a reputable platform will usually come with an automatic record of transaction time and value (including the market value of each). Generally speaking, crypto platforms do not offer such a service, so manual recording is a must.
Avid crypto traders may find the existing attitude of the IRS to cryptos unsatisfying, and also irritating when compared to other nations around the world. But for now it’s what citizens must abide by at tax time. If you are intent to be a daily trader, it is important to be on the safe side and keep records of each transaction as you go along. Frustrating yes, but a habit that can be built.
Is There a Legal Way Around This?
If you are a more infrequent crypto trader that wants to avoid such headaches, there is a couple of ways to legally reduce all this red tape without annoying the IRS.
- Seek to keep transactions to a minimum: once you buy a crypto seek to hold it long term.
- Once you decide to cash in cryptos for USD do it in as few steps (transactions) as possible
- Build the habit of noting the present value of each currency when a trade occurs
Ultimately, the popularity of crypto trading – and the fact many Americans statistically won’t fill out their tax returns properly – means an audit of your return due to your cryptos alone is unlikely. Nonetheless, if it does happen, you will be required to show proof of your earnings and losses.
Use The Current Law To Your Advantage
Though the law is always prone to evolution – and cryptocurrencies’ volatile nature makes it a prime candidate for reform – the IRS can and will only tax you on the law of the land as it applies today. And returns must be filed on that basis, but can also be used to your advantage.
This applies especially to trades when you’ve had a capital gain on an asset owned for under a year. The percentage of the gain the government will want depends on your personal income, but it’ll usually be either 0%, 15% or 20%, and after one year of ownership the rate will drop.
So when it’s possible, hold your cryptocurrencies long term.
And don’t forget you can also declare losses via cryptocurrency. This applies not only to trades that have seen a decrease in value, but also if you’ve had the misfortune of having cryptos stolen. Be sure to have existing records of your proof of purchase of any lost cryptos just in case of an audit, but otherwise declare and let Uncle Sam shoulder some of your capital loss.
Have questions? Contact Venar Ayar. 248.262.3400