Filing Your Cryptocurrency Taxes The Right Way

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In a Press Release, the IRS has announced that it has begun sending letters to taxpayers who might have failed to report their cryptocurrency income and capital gains. More than 10,000 taxpayers are expected to receive letters by the end of August.

As such, it is vital for crypto investors to start taking their taxes seriously. Cryptocurrencies are treated as property under federal tax law – which means you have to report capital gains for them.

Capital gains are calculated by subtracting the cost-basis (purchase price) from your selling price. Keep in mind that long-term capital gains are taxed lower on average than short-term capital gains. The US typically supports FIFO and LIFO for cost-basis calculations, a somewhat controversial method known as ‘Specific Identification’ might also be acceptable but the IRS has not clarified it’s stance on it yet. An in-depth comparison of the different methods can be found here.

Trading cryptocurrencies

Buying cryptocurrencies with fiat currency is not taxable but selling them is. Still, you need to record your transactions as you’ll need them to calculate your cost-basis.

Ironically, trading cryptocurrencies with other cryptocurrencies is subject to capital gains tax, the same goes for stablecoins. Even if the the altcoin you bought dropped in value afterwards, you would still need to pay for the capital gains made from the time you bought it. Fortunately, you have the option to sell the altcoins at a loss and not be liable to tax since the net value becomes negative, as long as you sell them within the year.

Paying with digital currencies for goods and services also incurs taxes.

Mining/Staking/Masternode Income

Mining cryptocurrencies is also a taxable event. The IRS recognizes two types of mining activity: hobbyist and business. Operating a mining rig with the inclination of making profit would likely be considered a business. Utilizing older hardware for mining altcoins would likely be considered as a hobbyist activity.

Crypto mining businesses incur a 15.3% self-employment tax while hobbyist miners do not. Hobbyist miners, however, incur taxes from any income generated from their mining activity and have a lesser range of deductions compared to business miners.

The hobbyist and business categories also apply to staking. Income generated by engaging in proof of stake blockchains must be declared and is subject to the same taxation mechanics as mining. The same goes for income generated from masternodes.

Hard Fork Gains

Hard forks are either categorized as ordinary income or dividends, depending on which law firm you work with. Since the IRS has not released any proper guidelines yet, most investors opt to only report when their coins from the fork are sold. Income generated from hard forks have zero cost-basis since they require no additional cost from participants.

ICO/STO/IEO

Taking part in ICOs, IEOs, STOs, and many other crowdsale fundraising models incur taxes since investors are buying a cryptocurrency with another cryptocurrency. The cost-basis is the price you paid on the date of the token sale but the transaction date is the date in which you receive the issued tokens.

What’s Exempted From Tax

Moving your crypto funds between your wallets and exchange accounts is not a taxable event but logging them is essential in order to get an accurate cost-basis.

Futures trading and margin trading with coins is also not taxable. However, if you make any gains or losses when settling your positions, they will be classified as capital gains and would need to be reported.

Using cryptocurrency for crypto-backed loans does not incur taxes. However, if the loan gets liquidated, it will be classified as ordinary income and becomes taxable.

Gifts and donations are generally exempted from tax but if the gift is sufficiently large – over $15,000 – you may have to report it separately.

Decreasing Your Tax

There are several ways to decrease your taxable gains from cryptocurrency activities. Moreover, losses can be deducted not only from your capital gains made from cryptocurrency activities, but your entire capital gains made that year. For instance, if you sold your crypto at a loss, that loss is deductible against your entire income. However, this rule is only limited up to $3000.

Crypto mining also has its share of tax deductibles. Hobby miners can deduct from their profits the expenses for mining hardware, electricity used, internet service, mining pool fees, accounting. Business miners typically have more deductions and include everything a hobby miner deducts, plus home or office costs, etc.

Trading fees are generally deductible. However, only qualified day traders can deduct business expenses for their trading activity.

How To File Your Tax Report

First you need to download all transactions from your wallets/exchange accounts since the beginning. This is a common mistake for investors as most would only report their transactions from the specified year when the cost-basis also depends on their old transactions.

You need to match the transfers between your wallets/accounts. Afterwards, you will need to assign market rates to all your crypto trades (considered sells). That’s when you calculate your capital gains and submit them in your
Form 8949 and
Schedule D.

You must also report your income under the “other income” section of line 21 of
Schedule 1 — Additional Income and Adjustments to Income. If applicable, you should report your holding to FBAR and FATCA.

The whole process is quite weary and time-consuming which is why you may want to look at a cryptocurrency tax calculator that does the work for you.