Cryptocurrencies and Taxes: What you Need to Know
Since we have a huge stack of new tax laws, IRS has been focusing on figuring out how they are going to work, and hasn't really done much with the world of cryptocurrencies. As a result, there's not a lot of investors who really understand the issues and implications of how to handle tax reporting for crypto gains or losses.
Here's some essential data to help you navigate the troubled waters of tax reporting for cryptos.
Everyone who holds cryptos should know that taxable gains (or losses) are "realized" (meaning they become taxable) when you sell cryptocurrency.
If you bought 4 bitcoins at $8,000 in August and sold 1 for $10,000 in December your taxable gain is $8,000 (less any commissions or fees you may have paid). There's a taxable a gain on the coin you sold. If you held it less than 12 months (short-term) the gain is taxed as ordinary income. If you held it 12 months or more, it qualifies for long-term capital gains tax rates.
IMPORTANT - you don't have to withdraw or spend the funds for the gain to still be taxable. If the proceeds from the sale are sitting in your Coinbase US dollar wallet, you still owe tax on the gain.
Additionally, exchanging one coin for another is a taxable event. If you sold 1 bitcoin (with a $8,000 cost basis) for 30 litecoins valued at $400 each ($12,000 total), you realized a $4,000 gain – just as if you had sold bitcoin for $12,000.
Not-So Common Knowledge
Spending crypto is the same as selling it.
If you purchased a $24,000 car with 2 bitcoins, it's the same as if you had sold those bitcoins for $12,000 each and used the proceeds to purchase the car. If your cost basis in the bitcoins was $7,000 each, your total gain is $10,000. So, not only do you have to pay for the car, you have to pay tax on the profit you made while paying for it.
However, good news! Donations made in cryptocurrency are deductible! This has immense potential if your cryptos have gone up in value. Let's assume you donate 5 bitcoins to charity valued at $12,000 each ($60,000 total) and that your cost basis is $8,000 each ($40,000 total). You can deduct the greater of the market value or the cost basis, so that means you get a $60,000 donation deduction, and you don't have to report or pay tax on the $20,000 gain.
CAUTION: Make sure you document the transaction, both in terms of the payment itself, and also by getting a receipt, statement or acknowledgment letter from the charity BEFORE you file your tax return. Believe it or not, if you don't have documentation for BOTH the payment and the charity receipt in hand BEFORE you file your return, IRS can disallow the entire deduction simply because the paperwork isn't “correct”.
Something You Probably Don't Know
IRS has not said which methods are acceptable for calculating cost basis for gains and losses. However, most tax experts believe that when the IRS does get around to tackling this issue, it's going to treat cryptos the same as securities.
For stocks and index funds FIFO (First In, First Out) is required unless you specifically match a lot you sold to a lot you purchased, and do so in writing at the time of the transaction. That could be difficult with cryptos. You could potentially also use Last In, First Out (LIFO) and the Average Cost methods for accounting for your crypto sales. But if you choose the wrong approach, it could be costly.
So – what's the difference between FIFO, LIFO or Average Cost? While FIFO is safer, it will result in a higher tax bill for most who buy and sell cryptos.
As an example, let's assume you bought 1 bitcoin in September for $5,000 and 1 bitcoin in November for $10,000 ($15,000 invested with an average cost of $7,500). If you sold 1 bitcoin in December for $15,000 your FIFO cost basis was $5,000 (the first one you bought), which would result in a gain of $10,000. Under LIFO (last in, first out) your cost basis would be $10,000 (the last one you bought), which would result in a gain of only $5,000. Using Average Cost, your cost and gain are both $7,500 (the average of $5,000 and $10,000)..
If the IRS does indeed decide to treat crypto sales like securities sales, those who chose LIFO or Average Cost would likely have under-reported their tax liability. While some may be tempted to take an aggressive approach, it's quite possible the IRS will require FIFO in the future – possibly with retroactive enforcement.
What Everyone Should Know
It's probably only a matter of time before crypto brokerages and exchanges have to report as traditional brokerages do today. On February 23, 2018, Coinbase announced it had been required to provide the IRS with information on 13,000 customers. This is likely a sign of things to come. If you under-report, you will probably be facing back taxes, penalties, and interest somewhere down the line.
There are numerous new tools on the market to help you track your purchases and sales and calculate your taxable gains and losses. But regardless of the tool you use, the quality of the reporting is only as good as the quality of the information you enter.
So, be sure to include all crypto exchange accounts and digital wallets; review all transactions – especially transfers, payments, gifts and donations – to confirm they are correctly classified; and
spot-check some of the calculations to make sure they are right. Just because it's in there somewhere doesn't mean it's correct.
And, if this all seems confusing, or you want some help to make sure you get it right, just give us a call – we're here to help.