With the growing popularity of cryptocurrencies as a form of investment, it was only a matter of time before the taxman became interested. In 2018, the IRS firmly stated that anyone owning and dealing with cryptocurrencies needs to include this when they file their taxes. So, if you own any cryptocurrency, you definitely need to take seriously the way this impacts your tax liability.
In this article, I want to talk cover how you can minimize your crypto tax liability.
- Tax and Cryptocurrency
- Keep Meticulous Records
- Form 8949
- Long Term vs. Short Term Investment
- Using Crypto Losses To Offset Tax
- The Wash Sale Rule
- Consider Hiring A Tax Professional
Tax and Cryptocurrency
A good place to start is a brief overview of exactly how cryptocurrencies are taxed in the US. Back in 2014, the IRS released guidelines for crypto traders and tax. The most important part of this for our purposes is that cryptocurrencies are viewed by the IRS as property. In this sense, when it comes to tax crypto is treated the same way as stocks and shares, gold or real estate assets. Confusingly, this means that cryptocurrency is not treated as currency!
In practical terms, this means that cryptocurrency must be declared on tax forms in the same way as you would declare stocks. Specifically, this means that cryptocurrencies are subject to capital gains tax, meaning you must declare any gains or losses made on cryptos in a given year.
Keep Meticulous Records
This one will come as no surprise. As with any taxable asset, it is really important that you keep a record of everything. With crypto, this can get tricky, especially if you use multiple exchanges, different wallets, and cold storage solutions. On the flip side, most wallets and exchanges will offer a complete log of your withdrawal, deposit and trade history. This can be invaluable, although it is definitely wise to keep a separate log yourself.
As a side note, if you are keeping a digital record of your crypto incomings and outgoings, make sure not to include any of the security details for your accounts. This is standard procedure – always store these details physically, not on internet-connected devices. That way, you reduce your hacking risk.
Your records need to include:
- The date you purchased the cryptocurrency.
- The amount that cryptocurrency was worth in dollars at the time of purchase.
- The date you sold or traded the cryptocurrency.
- The amount that it was worth at the time you sold or traded the cryptocurrency.
- The total gain or loss you made in dollars.
- Any fees paid to exchanges or wallets.
Form 8949 is the paperwork you need to fill out telling the IRS about all your capital assets. You can take a look at it here. As I have already said, this is how the IRS class cryptocurrencies, meaning that every crypto trade you have done this tax year needs to be recorded on Form 8949.
This is why keeping meticulous records is so important. If you have kept a careful record of all your crypto trading throughout the year, then filling out form 8949 will be easy.
Long Term vs. Short Term Investment
As cryptocurrency is treated as property by the IRS, it becomes taxable at the moment you sell it for more than you bought it for. This includes exchanging it for another cryptocurrency. What this means is that the more trades and sales you do, the more you open yourself up to capital gains tax.
This can be tricky in the volatile world of cryptocurrency. Prices of cryptocurrencies can fluctuate so rapidly that a common investment strategy is one of short term gains. Buying a currency, then selling again quickly after a jump in price is the name of the game. While this is a rational approach to such a volatile market, it means that you open yourself up to paying much more tax, because every profitable trade is a taxable event.
To avoid this, you can alter your investment strategy to be slower and more long term. Essentially, if you hold onto assets for longer and do fewer trades, this means fewer opportunities to pay capital gains tax.
Long term investment in crypto comes with its own set of risks though, the most obvious one being that long term prediction of crypto prices is really difficult due to high levels of volatility. If you pass up the opportunity to record a short term gain, there is no guarantee the opportunity will come around again.
There is no tried and tested answer here. To really maximize your returns when trading crypto, the truth is you will probably need to balance both of these strategies.
Use Crypto Losses To Offset Tax
Ideally, you would not ever lose on a crypto trade. Realistically though, the cryptocurrency market is so volatile you are almost certain to suffer some losses at some point in your trading. The important thing is to be smart about these losses. There are ways that you can use losses to your advantage when it comes to tax.
If you do make a loss, you can use this to offset other areas of income that you are being taxed on. If, when you total up all of your crypto tradings for the tax year, you find that overall you have made a loss, up to $3000 of this loss can be used to offset tax on other incomes, such as your salary. In this way, you can use the loss to your advantage, because it will lower the amount of income tax you need to pay.
Similarly, if you have other capital assets beside cryptocurrencies (like property or stocks) any gains you made on these will be weighed against losses made on crypto, which will lower the amount of capital gains tax you pay on these other assets.
The Wash Sale Rule
The Wash Sale Rule is a way of using the fact that an asset you own has lost value to minimize tax. The Wash Sale Rule currently applies to cryptocurrencies, although it is worth stating that tax law and cryptocurrency are still in their infancy. It is conceivable that in the future the law will change and the Wash Sale Rule will no longer apply to cryptos.
Essentially, because crypto is treated the same way as stocks or property, this means its value is only realized when it is sold. This can be used to your advantage when you own crypto that has decreased in value. If you sell that crypto at the end of the tax year and then buy it back again at the same price you have realized this loss in value on paper, meaning you can now use this loss to offset taxes in the manner I described above.
As an example, if you have a wallet of Bitcoin that you bought when one Bitcoin was worth $6000, those Bitcoin right now have fallen in value. You might not care, because you are planning to hold onto this Bitcoin for years, with the expectation that it will rocket up in price again at some point in the future. However, you could sell those Bitcoin now for $4000, realizing a loss of $2000. The Wash Sale Rule means that you can then immediately buy back your Bitcoin at the same price, but still use that $2000 loss to offset your taxes.
Consider Hiring A Tax Professional
While calculating capital gains tax might not be too tough, if you are involved in more complicated, high-volume crypto trading, it could be worth talking to an accountant. Although this might seem like an unnecessary expense, getting professional help with your taxes could actually save you money. Also, if you are a full-time trader, using an accountant will free up more time for you to focus on trading.
When choosing an accountant, there are a number of key areas to consider. Check out this FAQ on CPAs (certified private accountants) for a detailed list. It is also really important that your chosen accountant is familiar and comfortable with the world of cryptocurrency. It is still a relatively new field, and one that moves very quickly, so you are going to need someone who can keep on top of it. In particular, keeping on top of regulatory changes regarding crypto is going to be critical.
The world of tax and cryptocurrency is a complicated one, there’s no doubt about that. However, hopefully, this article has given you some useful advice on how to minimize your crypto taxes. In particular, make sure that if you have any crypto that has lost value, use this loss to offset other taxes – that way something good can come of the disappointment of having crypto lose value.
A final word of warning, if you are trading crypto it is really important that you stay on top of the regulatory news from the IRS or you may put yourself at risk (see this article about IRS criminal investigations). Crypto tax law is such a new field that, much like the cryptocurrencies themselves, can be quite volatile. Staying informed is really half the battle when it comes to crypto taxes.
About the author
Bryce Welker is an active speaker, blogger, and tutor on accounting and finance. As the Founder of Crush The CPA Exam, he has helped thousands of candidates pass the CPA exam on their first attempt