Q: How Do I Account For Cryptocurrency Gains
As we discussed above, accounting for cryptocurrency gains is one of the biggest challenges many investors face when it comes to tax reporting and compliance. As a general rule, cryptocurrency investors should maintain transaction logs that are as detailed as possible and, once again, it is advisable to seek advice from an attorney with specific experience in this area.
Ordinary Income On Form 1040 Schedule 1
Although crypto profit is often reported as capital gains, there are instances where it is recognized as ordinary income. These include crypto mining and staking, hard forks and airdrops, and crypto lending interest.
This crypto income is reported on Form 1040 Schedule 1.
At the top of the form, it asks, At any time during the last tax year, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency? If you owned or transacted crypto in the last tax year, you should check yes even if you had no taxable events to report on the form.
Total crypto income that youve received personally is included in the Form 1040 Schedule 1 Additional Income and Adjustments to Income on line 8 “Other income.”
Crypto tax software will calculate this total from your transaction history, so youll know exactly how much income you need to report on your Form 1040 Schedule 1.
Form 8949 & Schedule D
Form 8949 is used to report your cryptocurrency & NFT gains and losses. If you receive a complete and accurate 1099-B from an exchange you can enter those numbers on this document. If you traded NFTs, you would have to rely on your manual records or connect your Metamask wallet to a cryptocurrency tax software to get the numbers needed to fill out this form.
Schedule D summarizes what you reported on Form 8949. This schedule will also show your stocks & security gains & losses.
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Cryptocurrency’s Appeal As An Alternative Payment Method
The term cryptocurrency refers to a type of digital asset that can be used to buy goods and services, although many people invest in cryptocurrency like shares of stock. Part of its appeal is that it’s a decentralized medium of exchange, meaning it operates without the involvement of banks, financial institutions, or other central authorities.
Cryptocurrency is also secure transactions are encrypted with specialized computer code and recorded on a blockchain a public, digital ledger in which every new entry must be reviewed and approved by all network members.
You may have heard of Bitcoin or Ethereum as two of the more popular cryptocurrencies, but there are thousands of different forms of cryptocurrency worldwide.
How To Determine If You Owe Crypto Taxes
You owe crypto taxes if you use your crypto in any way and it has increased in value from when you first bought it.
Here are the different types of taxable events for cryptocurrency transactions:
- Selling cryptocurrency for a fiat currency
- Using cryptocurrency to purchase goods or services
- Trading different types of cryptocurrency
These are only taxable events if the value of your crypto has gone up. To determine if you owe crypto taxes, you need the cost basis, which is the total amount you paid to acquire your crypto. Then you compare that to the sales price or proceeds when you used the crypto.
Let’s say you previously bought one bitcoin for $20,000. Here are examples of taxable events:
- If you sell one bitcoin for $50,000, you’d report $30,000 in gains.
- If you use one bitcoin to purchase a $45,000 car, you’d report $25,000 in gains.
- If you trade one bitcoin for $50,000 of another cryptocurrency, you’d report $30,000 in gains.
Trades between coins are where crypto taxes get complicated. A crypto trade is a taxable event. If you trade one cryptocurrency for another, you’re required to report any gains in U.S. dollars on your tax return.
Every time you trade cryptocurrencies, you need to keep track of how much you gained or lost in U.S. dollars. That way you can accurately report your crypto gains or losses. If you’d rather keep it simple, cryptocurrency stocks could make it easier to track gains and losses compared to buying and selling specific coins.
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The Challenge For Crypto Traders
As you can see from the examples above, calculating your capital gains and losses from your crypto trading activity requires records to keep track of your cost basis, fair market value, and USD gain or loss every time you dispose of a crypto .
Without this information, you arenât able to calculate your realized income from your trading activity, and you arenât able to report it on your taxes.
This is extremely challenging for many cryptocurrency investors as most havenât been keeping detailed records of their investing activity. Trying to track the cost basis and USD prices for all of their cryptos across all of their exchanges, wallets, and protocols at any given time quickly turns into a difficult, if not impossible, spreadsheet exercise.
This is the reason why hundreds of thousands of crypto traders are turning to crypto tax software like CryptoTrader.Tax to automate all of their crypto tax reporting. You can sign up for a free account here.
Crypto Exchanges May Not Send You Tax Forms
You can’t rely on crypto exchanges to send you tax forms. Although many top crypto exchanges send 1099 forms to clients who meet trading minimums, not all of them do this. And some types of 1099 forms don’t include a full record of your trades.
Remember, whether you receive tax forms doesn’t determine if you owe crypto taxes. If you sold crypto and made money on it in 2021, you need to pay taxes on the gains. That’s why you should keep good records of all your crypto transactions.
The U.S. government recently passed a bill that requires crypto exchanges to issue a Form 1099 for all their customers, starting with the 2023 tax year. Once that happens, it should make reporting crypto gains and losses easier.
It will probably take longer to do your taxes this year if you have crypto trades to report. That’s time well spent, because it will help you avoid any issues with your taxes later.
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How Are Hard Forks Taxed
If a certain cryptocurrency that you are holding goes through a hard fork which âoccurs when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger,â the new forked cryptocurrency you receive is taxed as income.
Your cost basis in the newly received cryptocurrency becomes the income you recognize.
How Does The Irs Know About Your Crypto
The IRS uses a variety of tactics to detect cryptocurrency investments and unreported income. The most predominant of which is the 1099 reporting system.
Major exchanges like Coinbase, Gemini, Uphold, Kraken, and others report certain customer activity to the IRS using form 1099-K and/or other related 1099âs. These 1099âs all serve the same general purpose: to report non-employment related income to the IRS.
Both you and the IRS get sent a copy of these forms at year-end.
If the IRS receives a 1099 from your crypto exchange but sees no cryptocurrency income reported on your taxes, your account will be flagged and an automated CP2000 letterwill be sent alerting you of your non-reported income and tax liability.
You can learn more about how 1099-K works for your crypto exchange activity here.
Outside of 1099 reporting, the IRS works with blockchain analytics companies like Chainalysis to track cryptocurrency movements directly on-chain. Since 2015, the IRS has spent more than 10 million dollars on Chainalysis contracts. This data is used to identify tax fraud and money laundering.
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Do I Have To Report Cryptocurrency On My Taxes
Yes. Cryptocurrency is considered a form of property by the IRS and is subject to capital gains tax upon disposal and ordinary income tax when earned.
Remember, when major exchanges send you a Form 1099, they file an identical copy with the IRS. If you donât report income on your tax return from the platform that filed a 1099 on your behalf, your tax return may be flagged and you could automatically be sent Notice CP2000 about your unpaid tax liability.
For more information detailing exactly how cryptocurrency is taxed, check out our complete guide to cryptocurrency taxes.
Do You Pay Taxes For Holding Cryptocurrency
If you simply buy Bitcoin or another cryptocurrency and hold it in a wallet, you do not have any sort of tax reporting requirement as you havenât realized a gain or loss on your investment yet.
Once you sell, trade, or trigger a taxable event by disposing of the coin, this is when you realize a capital gain or loss.
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How Does The Gst/hst Apply To Cryptocurrency
Where a taxable property or service is exchanged for cryptocurrency, the GST/HST that applies to the property or service is calculated based on the fair market value of the cryptocurrency at the time of the exchange.
If your business accepts cryptocurrency as payment for taxable property or services, the value of the cryptocurrency for GST/HST purposes is calculated based on its fair market value at the time of the transaction.
Keep all records that show how you calculated the fair market value.
If Classified Under Capital Gains :
If the crypto-transactions are classified as investments, they will be considered capital gains or losses under the head capital gain.
If the sale value of the transaction is more than the cost, it will be regarded as capital gain, and if the price is higher than the sale value, it will be considered capital losses.
As per the applicable income tax slabs, short-term capital gains tax will be leviable if crypto assets are held for less than three years . If the crypto-assets are sold after holding the investment for three years , they will be treated as long-term investments and taxed at 20% with indexation benefit.
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Capital Gain & Loss On Crypto
A capital gain or loss is incurred on trading or selling cryptocurrency. Just like traditional assets, capital gains will be incurred when the price of selling is greater than the price it has been acquired for . On the other hand, a capital loss is incurred when the price of selling is lesser than the price it was acquired for.
Before selling a capital asset, you must figure out if the investment was short-term or long-term. Long-term gains and losses are incurred when the assets were held for more than a year, whereas short-term capital gains and losses are incurred when the assets have been held for less than one year.
If You Lost Money On A Sale You Can Deduct It
If you sold cryptocurrency for less than you paid for it, you can deduct the loss on your taxes. You can use that capital loss to either lower your capital gains or reduce your ordinary income.
With capital gains, you can use capital losses to offset what you made. Let’s say you made $15,000 in profit selling Ethereum in 2021, but you also lost $13,000 on Dogecoin . You’d report both on your taxes, and you’d owe $2,000 in capital gains .
The rules are a little different if you lost more than you made. You can use capital losses to lower your income by up to $3,000 if you’re single or married filing jointly . If you have more than that, you can carry the excess losses forward to later tax years.
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Who Can Help Me Figure Out My Bitcoin Taxes
If you’re looking for more hand-holding, we urge you to consult a tax professional. The basic tax code is notoriously complex, and crypto activity can get awfully complicated quickly. When in doubt, hire a pro.
“I always tell people to inform your tax return preparer early on that you invest in cryptocurrency. Tell them during the year that you have crypto and you’re going to transact in crypto,” said Hunley. “And if you’re going to invest in cryptocurrency, if you can hold it for more than one year, you need to do that. Then you get a lower tax rate, and you want to take advantage of that.”
And, as with everything cryptocurrency-related: Do your research, pay your taxes and caveat emptor.
Don’t Blindly Rely On Exchange
Note that the tax forms you download from an exchange may not be entirely complete and accurate if you use multiple exchanges & wallets, frequently transfers coins in and out of those platforms, use decentralized exchanges or self-custody assets.
If this is the case, it is highly recommended to use a crypto tax software to reconcile your cryptocurrency activity across multiple exchanges & wallets and arrive at the correct capital gain amount which you have to pay taxes on.
Now that you know which tax reports to expect from exchanges and what they mean, let’s see what IRS tax forms you need to file with your personal income tax return to comply with crypto taxes.
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The Importance Of Working With A Boston Tax Lawyer Who Can Provide Cryptocurrency Tax Assistance
With these types of issues in mind and understanding the potentially-substantial tax, interest and penalty obligations that come with failing to timely report cryptocurrency transactions most cryptocurrency investors will benefit greatly from the assistance of an experienced tax lawyer. This is true with regard to prospectively addressing tax reporting issues, retrospectively amending incomplete tax returns, responding to IRS warning letters, and defending against audits and investigations.
An experienced tax lawyer will be able to help you with cryptocurrency-related tax compliance in numerous respects, including:
- Determining which of your cryptocurrency transactions qualify as taxable events that need to be reported to the IRS
- Determining whether you have any local, state or international tax obligations related to your cryptocurrency investments
- Assessing your potential exposure and executing an effective strategy with regard to disclosing previously-unreported cryptocurrency transactions
- Filing all necessary new and amended tax returns
- Representing you in direct communications with the IRS and other tax authorities, including during tax audits and criminal tax investigations
- Negotiating offers in compromise and deferred prosecution agreements
- Developing tax strategies for avoiding future issues at the state, federal and international levels
How Do Nft Taxes Work
Non-fungible tokens, or NFTs, have exploded in popularity amongst crypto native audiences and beyond.
From a tax perspective, NFTs are treated as property, similar to other cryptocurrencies. When you buy an NFT and later sell it, you incur a capital gain or loss that gets reported on IRS Form 8949.
For more information, check out our Complete NFT Tax Guide.
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Get Your Investment Taxes Done Right
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The above article is intended to provide generalized financial information designed to educate a broad segment of the public it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.
What Is Form 1099
Form 1099-MISC is designed to report âmiscellaneousâ income to taxpayers and the IRS. This form is typically used by cryptocurrency exchanges to report interest, referral, and staking income to the IRS.
In most cases, exchanges choose to send Form 1099-MISC when a customer has earned at least $600 of income.
Form 1099-MISC does not contain information about cryptocurrency capital gains and losses.
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How To Handle Cryptocurrency Transactions On Your Tax Return
You can usually download a transaction report from your cryptocurrency exchange platform, including all of your buys, sells, and exchanges of cryptocurrency in your account. If all of your cryptocurrency transactions occur on one exchange, gathering the information you need to report transactions on your tax return should be relatively easy. If you have cryptocurrency transactions on several exchanges, you’ll need to download several reports.
Bitcoin As Specified Foreign Property
The CRA views bitcoin as specified foreign property under Section 233.3 of the Income Tax Act. Often, people make the mistake of thinking foreign property only refers to real estate, but the CRAs definition includes many other types of assets.
Funds in foreign bank accounts, shares of foreign corporations, interests in foreign mutual funds, land and buildings outside of Canada, life insurance issued by a foreign issuer, and even precious metals held outside of Canada all carry the foreign property classification. As such, the CRA now considers bitcoin part of this category.
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How To Report Your Cryptocurrency Earnings On Your Tax Return
In the last few years, cryptocurrencies are on the rise with a sudden surge of prices, which attracted several investors. In the previous year, the value of crypto-coins has reached an all-time high as well as an all-time low. Due to that, there are users who made a hefty sum of profits, while a few users lost a massive sum of investments.
You must pay taxes on your bitcoin and other cryptocurrencies as they are taxable. For tax reasons, the IRS views crypto possessions as property. It means that the virtual currency will be taxed similarly to other properties you have, such as gold, stocks, bonds, and more.