Figuring out how to pay cryptocurrency taxes can be challenging, confusing, and time-consuming. As of now, the IRS hasn’t been much help. The only guidance the agency has released on crypto taxes dates back to 2014. No wonder so many people are skipping out on them altogether. In 2015, for example, just 800 Americans reported their crypto earning to the IRS. But with last year’s seemingly endless stream of new ICOs and the now almost mythical bull run of the market, the IRS is aware of the popularity of cryptocurrency and will be on the lookout for anyone who doesn’t report their gains. Tax evasion is a serious offense that can lead to a prison sentence and hundreds of thousands of dollars in fines.
Taxes, fines, regulations—isn’t that everything cryptocurrency was invented to circumvent? The dream of crypto is to one day leave behind the centralized control and oversight of government agencies and central banks. For now, however, cryptocurrency is an asset Uncle Sam gets a piece of, even if it’s unclear how big his slice should be. Whether you’ve made ten or ten thousand cryptocurrency transactions this year, it’s time to get serious about learning how to pay your cryptocurrency taxes. Fortunately, this guide has you covered.
The very first step in figuring out how to pay your cryptocurrency taxes is understanding what events are taxable in the first place. This requires knowing what kind of asset the IRS considers cryptocurrency to be. In the eyes of the U.S. government, cryptocurrency isn’t dollars or a “coin” or anything monetary. Instead, the IRS sees cryptocurrency as property.
Because the IRS treats your cryptocurrency assets like property, they’re subject to capital gains taxes. This means that you pay taxes on the increase in the value of your cryptocurrency holdings. Yet, it’s also possible for someone to receive cryptocurrency as a payment or wage from an employer or contractor. In that case, these cryptocurrency earnings are subject to standard income taxes.
Since virtually everyone is familiar with how income tax works, let’s focus on capital gains. Three taxable events pertain to capital gains. These taxable events apply to you if you’ve bought, sold, or traded crypto this year. Taxpayers must report all of them to the IRS in U.S. dollars. The three events include:
To review, your crypto is property, as far as the IRS goes. If that property increases in value and you cash in, you have to pay capital gains taxes. But considering how many young people trade crypto and how unlikely they are to own other property, capital gains may be unfamiliar tax territory for many crypto investors. You should always consider consulting a licensed tax professional to work out the particulars for your federal, state, and local tax rates and tax brackets. In the meantime, here’s some easy-to-understand guidance about how the capital gains tax law applies to crypto.
Here’s a simple formula: Capital gains = fair market price – cost basis.
Let’s break that down. The fair market price is simply the value of your cryptocurrency asset when you sold or exchanged it. The cost basis is just how much you paid for that cryptocurrency plus all the other costs associated with acquiring it.
The next thing to know is that there are both short-term and long-term capital gains taxes. Short-term applies to crypto you buy and then sell or exchange in the same calendar year. Long-term, on the other hand, applies to crypto you buy and sell or exchange after one calendar year. Here’s where your individual tax bracket (based on income) and your local and state tax rates make a big difference in how much you’ll pay on your short- and/or long-term capital gains. In general, rates on long-term capital gains are always lower. In other words, the longer you hodl on to your cryptocurrency, the less tax you’ll pay on it when you sell or exchange it.
Now that you know how to calculate your capital gains on any sale or exchange of crypto, here’s how to pay your cryptocurrency taxes on your capital gains.
First, it’s time to collect your data. Use your records to find the following information for each cryptocurrency transaction you made this year.
If you’re even a hobby trader, let alone a serious cryptocurrency investor, your stomach has probably dropped by this point. Whether you’ve made dozens, hundreds, or thousands of transactions, tracking down this data can be a real pain. The matter gets worse when you realize that margin trading, crypto-to-crypto exchanges, are also taxable events.
Sadly, it’s true. You need those four data points not just when you cash out crypto to a fiat currency, but every time you exchange one cryptocurrency for another and every time you use crypto to pay for something else. The hardest part is figuring out the original value or cost basis of your crypto when you acquired it, especially if you paid for it a while ago.
Rest assured, since all of your transactions are immutably recorded on the public blockchain ledger, that data is out there and you can access it. As tax concerns become more prominent, many major cryptocurrency exchanges and popular software wallets are starting to provide services to help you track and look up the cost basis of your crypto assets both when you acquired them and when you moved them.
Figuring out how to pay cryptocurrency taxes requires an almost Sisyphean effort at accounting and bookkeeping. And the IRS doesn’t just want your final capital gains numbers. They also want to see your investments detailed.
For that reason, reporting your cryptocurrency capital gains taxes requires (at least) two forms. First, there’s Form 8949. Use this form to detail your capital gains and losses for each sale, exchange, or purchase using cryptocurrency. Second, there’s Form 1040 Schedule D, which you use to report your total gains or losses.
Now that you’ve been hit with the hard reality of capital gains taxes on your cryptocurrency transactions, you may be wondering if there are any scenarios when you don’t have to pay taxes on your cryptocurrency. In fact, there are two.
In the first place, you don’t have to pay any capital gains taxes on your crypto if you don’t have any capital gains. Buying cryptocurrency assets isn’t a taxable event by itself. And simply HODLing crypto assets doesn’t subject you to tax liability. In fact, as mentioned earlier, holding on to your assets for longer than a calendar year can actually lower your taxes.
Similarly, if you happen to lose value on your cryptocurrency assets, for example by selling or exchanging it at a price below your cost basis, you can report capital gains losses to the IRS. Capital gains losses reduce your overall tax liability. So, if you don’t win the crypto market this year, make sure you let the taxman know.
Secondly, tokens, like those issued during ICOs, have no tax liability. That’s because you can only exchange tokens for other cryptocurrencies. In other words, you only have to pay taxes on your crypto assets that can be converted directly to USD, like Bitcoin and Ethereum.
Beginning in January 2018, two important amendments were added to federal tax law that will have a huge impact on how cryptocurrency traders report their taxes.
The first amendment has to do with something investors call the like-for-like loophole. Using this loophole, technically called a 1031 exchange, investors can swap one like-kind business or property asset for another without having to pay capital gains taxes on the asset swapped. 1031 exchanges are exceptions to the normal rule since the IRS treats most swaps as taxable sales. Because the IRS also says crypto is property not currency, many investors assumed 1031 exchanges could apply to cryptocurrency.
But the massive tax bill signed by President Trump in December limits 1031 exchanges to real estate holdings exclusively. For crypto traders and investors, that means no more like-for-like loophole. All currency swaps are taxable.
The second amendment deals with the Cryptocurrency Tax Fairness Act. Introduced by Republican Rep. David Schweikert of Arizona, the Act would exempt all cryptocurrency transactions below $600 USD from IRS reporting requirements. But Congress’ 2017 tax bill, signed by President Trump, effectively kills the Cryptocurrency Tax Fairness Act. And that means that this year, all of your crypto sales, exchanges, and purchases are taxable, down to the smallest transaction.
Given the overwhelming amount of work many crypto-traders will have to do to report their capital gains taxes and their income from cryptocurrency, it’s understandable that so many would take their chances and fail to report their digital assets to the IRS.
But that’s a big mistake. If the IRS audits you, being able to show that you made every effort to pay your taxes (and that you even know how to pay cryptocurrency taxes) will go a long way toward avoiding tax evasion charges. So, when you’re ready to sit down and bite the bullet, here are some tips for how to pay cryptocurrency taxes without losing your mind.
First, starting right this second, begin keeping track of all your cryptocurrency transactions in U.S. dollars. Start looking up your previous ones. Track dates and amounts paid/received for every transaction. If you lost your crypto wallet and need recovery, keep that in mind when recording transactions.
Second, take advantage of services and support from the cryptocurrency exchanges you use. Or email your cold wallet company to see if they have any services. These may prove indispensable and save you hours of work. If you’re a serious crypto investor, make sure you’re taking advantage of your exchange’s own tax reporting. For heavyweight investors, some exchanges will even issue proper 1099-K forms. Coinbase, for example, sends 1099-K reports to customers with $20,000 in gains or more and at least 2,000 transactions.
Finally, research the growing list of companies and services dedicated to filing taxes for cryptocurrency investors. Using blockchain technology, these companies can deploy algorithms that will give you the best tax result possible. This is often way better than simply relying on first-in-first-out accounting. FIFO methods often make your crypto tax liability much higher, so take advantage of these services.
Now you know how to pay cryptocurrency taxes, no matter if it is a coin vs token. When you’re paying them this April and feeling maybe a little sour about it, just remember: blockchain and digital money could one day render institutions like the IRS completely obsolete.
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