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5 Things To Understand When Doing Your Crypto Taxes

David Kemmerer

Cryptocurrency tax reporting is becoming increasingly important as governments begin to further scrutinize the asset class. In 2019, we’ve seen the IRS—the tax enforcement agency of the US—begin to increase cryptocurrency tax enforcement with warning letters sent to traders, new official guidance, and new documentation on tax forms like Schedule 1 of the 1040. This article discusses five things that are important for you to be aware of when doing your cryptocurrency taxes.

1. Cryptocurrency trades generate capital gains and capital losses

According to IRS official guidance, cryptocurrency is treated as property for tax purposes in the United States. This means that it is subject to capital gains and losses rules similar to other forms of property like stocks, bonds, real estate, and gold. You need to file taxes for your trades when you trade one coin for another or whenever you sell your crypto. Simply buying and holding cryptocurrency is not taxable; you only realize your gain or loss when you sell it.

For example, if you purchased 0.2 Bitcoin for $2,000 in May of 2018 and then sold it two months later for $3,000, you have a $1,000 capital gain. You report this gain on your tax return, and depending on what tax bracket you fall under, you pay a certain percentage of tax on the gain. Rates fluctuate based on your tax bracket as well as depending on whether it was a short term vs. a long term gain. This applies for all cryptocurrencies.

2. How to calculate gains and losses from crypto trades

To calculate your capital gains and losses on your crypto trades, apply this formula:

Fair Market Value – Cost Basis = Capital Gain / Loss

Fair market value is simply how much an asset would sell for on the open market. Again, with cryptocurrency, this fair market value is how much the coin was worth in terms of U.S. dollars at the time of the sale.

Cost basis is the original value of an asset for tax purposes. In the world of crypto, your cost basis is essentially how much it cost you to acquire the coin.

For example:
Let’s say you bought 5 ETH on Coinbase in January of 2018. You paid $2,000 for these ETH ($400 for each coin). After the market took a turn for the worse, you sold 3 of these ETH in July for $150 each.

In this example, your cost basis for the 3 ETH that you sold is $1,200 (3 * $400). You sold the coins for $450 total. This is your fair market value.

Doing the math: $450 – $1,200 = -$750.

You incurred a $750 capital loss. You would file this loss on your taxes and it would reduce your tax bill. You would not owe taxes on the 2 ETH that you are still holding because you haven't traded or sold them yet.

Keep in mind, coin-to-coin trades are considered both a “buy” and a “sell” for tax purposes.

3. You can save money on your taxes if you lost money trading crypto

If you realized losses throughout the year from trading crypto, these losses can and should be used to offset other capital gains as well as up to $3,000 in ordinary income. Just like your capital gains are filed on your tax return, your losses should be as well. These losses reduce your taxable income, and allow you to pay less overall taxes for the year. Keep in mind, you need to “realize” these gains to be able to write them off for your bitcoin tax reporting.

4. It is not the IRS’s responsibility to prove your taxes are accurate, it is yours.

A lot of crypto traders believe that the IRS does not know enough about cryptocurrencies to prove you falsely reported taxes. Even if this is true, it is entirely your responsibility to report and show you handled your cryptocurrencies.

The newly issued 2019 US income tax form begins with the question: “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

Answering this question will already put you on the radar if the IRS suspects false tax reporting, which is why it is important to file as accurately as possible.

5. Exchanges can’t provide you with accurate capital gains and losses reports

Because users are constantly transferring crypto into and out of cryptocurrency exchanges, the exchange has no way of knowing how, when, where, or at what cost basis you originally acquired your cryptocurrencies. It only sees that they appear in your account.

The second you transfer crypto into or out of an exchange, that exchange loses the ability to give you an accurate report detailing the cost basis and fair market value of your cryptocurrencies, both of which are mandatory components for tax reporting.

Ultimately, handling cryptocurrency taxes is not that difficult. Make sure you are keeping accurate records and are aware of the rules and regulations in your geography prior to getting started.

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