Cryptocurrency Tax Laws - Here’s What You Need to Know
There is no doubt that cryptocurrency tax laws are in their infancy. After the Internal Revenue Service (IRS) issued guidance on virtual currency to taxpayers in 2014, there has been almost no other legislation or guidance put forward. This article addresses the current state of cryptocurrency taxes and outlines the most important elements that you need to be aware of as a market participant.
1. Cryptocurrency is treated as property. This means that capital gains tax rules apply to any gains or losses
2. Calculating gains and losses are figured the same as buying and selling stock. That’s true as well in regards to cost basis, holding period, and triggering event
Okay, if you aren't familiar with tax laws, even the fundamentals can get confusing. Let's take a closer look into some of the more complicated pieces:
First, calculating your capital gains:
For tax purposes, capital gains and losses are calculated by determining how much your cost basis has gone up or down from the time you acquired the asset until there is a taxable event. In other words, your capital gain equals the current fair market value of your crypto minus its cost basis.
Fair Market Value - Cost Basis = Capital Gain/Loss
Wait, what is cost basis?
Cost basis is the cost that you pay for an asset. In other words, the cost basis for your cryptocurrency is the amount of money you put into purchasing it. This cost includes all brokerage and exchange fees that you paid to acquire the crypto. An example would look like the following:
You bought $500 of Litecoin back in November of 2017, that $500 bought you about 5.1 Litecoin. Let’s say you also paid Coinbase a 1.49% transaction fee on the purchase. Your cost basis would be calculated as such:
$500.00 + 1.49%*500 = $507.45 or $99.50 per Litecoin
What is a taxable event?
A taxable event is any event or occurrence that results in a tax liability. In the world of crypto, a taxable event occurs whenever crypto is traded for cash or other cryptocurrency, or whenever crypto is used to purchase goods or services.
The following have been taken from the IRS guidance from 2014 as to what is considered a taxable event:
- Trading cryptocurrency to fiat currency like the US dollar is a taxable event
- Trading cryptocurrency to cryptocurrency is a taxable event (you have to calculate the fair market value in USD at the time of the trade)
- Using cryptocurrency for goods and services is a taxable event (again, you have to calculate the fair market value in USD at the time of the trade; you may also end up owing sales tax)
- Giving cryptocurrency as a gift is not a taxable event (the recipient inherits the cost basis; the gift tax still applies if you exceed the gift tax exemption amount)
- A wallet-to-wallet transfer is not a taxable event (you can transferbetween exchanges or wallets without realizing capital gains and losses, so make sure to check your records against the records of your exchanges as they may count transfers as taxable events as a safe harbor)
- Buying cryptocurrency with USD is not a taxable event. You don’t realize gains until you trade, use, or sell your crypto. If you hold longer than a year you can realize long-term capital gains (which are about half the rate of short-term) if you hold less than a year you realize short-term capital gains and losses.
Explain fair market value like I am in 5th grade.
Fair Market Value is exactly what it sounds like: It is the market value (US dollar value) of your cryptocurrency at the time you disposed of it.
Well that makes logical sense. Your fair market value (how much you sold your crypto for) minus your cost basis (how much you spent to acquire it) equals your capital gain. This gain is what you must pay taxes on.
This simple world of capital gains calculation gets much more complicated when looking at crypto-to-crypto trades. Remember that a crypto-to-crypto trade is a taxable event.
This means that you need to know the fair market value of what your Bitcoin was when you traded it for Ethereum or any other altcoin. Let’s look at an example:
Let’s say you purchase $100 worth of Bitcoin including transaction and brokerage fees. That $100 currently buys about 0.01 Bitcoin. Now let’s say two months later you trade all of your 0.01 Bitcoin for 0.16 Ether. How would you calculate your capital gains for this coin-to-coin trade? Well, turns out, it depends on what the Fair Market Value of Bitcoin was at the time of the trade. Let’s say at the time of the trade, 0.01 Bitcoin was worth $160. This would make the Fair Market Value of 0.01 Bitcoin $160. You would then be able to calculate your capital gains based of this information:
160–100 = $60.00 capital gain
For that crypto-to-crypto trade, you would owe the government a percentage of your $60.00 gain. You then perform this same calculation for every crypto-to-crypto trade you committed throughout the tax year.
The Elephant in the Room
This calculation and process sparks a large variety of problems for crypto traders. Some traders have been trading crypto for months, possibly years, and haven’t been keeping track of the dollar value or Fair Market Value of their crypto at the time of the trade. This is information that they actually need to accurately file their taxes and avoid problems with the IRS. Depending on the volume of trades they have carried out, calculating gains accurately could become extremely tedious, and potentially impossible to do by hand or even with Excel if they haven’t been keeping track of Fair Market Value.
If your situation sounds like the above, it might make sense to automate this entire capital gains calculation process using CryptoTrader.Tax.
What if I lose money trading crypto?
We cover this topic in detail in our article here, but here are the basics: If your realized losses exceed your realized gains, you have a capital loss for tax purposes. You can claim up to $3,000 of capital losses and the amount of your loss offsets your taxable income for the tax year.
How do I actually report this stuff on my taxes?
You need two primary forms to report your crypto taxes. The 1040 schedule D and the 8949. Detail all of your trades out on your 8949 including the date acquired, date sold, proceeds, and cost basis, and then transfer the total gains to your Schedule D. For an in-depth discussion on this process, you can review our article here.
These rules are actually not that difficult to comply with. We recommend using some form of crypto tax automation software to generate your capital gains / tax reports, and then simply to give these documents to your tax professional or upload them into a platform like TurboTax to complete your entire tax return.
*This post is for informational purposes only and should not be construed as tax or investment advice. Please speak to your own tax expert, CPA or tax attorney on how you should treat taxation of digital currencies.