Filing taxes for cryptocurrency can be a confusing and daunting task for many individuals. The United States Internal Revenue Service (IRS) treats cryptocurrency as property subject to capital gains taxes. Knowing this appears to make filing crypto taxes simple, but crypto’s unique nature means there are many unanswered questions.
Accurately reporting gains and losses can be a nightmare. While everyone concerned about tax season knows that keeping accurate records of every crypto transaction is a must, there are other things to keep in mind.
There is a difference between short-term and long-term capital gains taxes, with tax rates varying depending on multiple factors. These capital gains tax rates are available online and are beyond the scope of this article, which will focus on avoiding potential issues with the IRS while filing taxes on crypto.
How to report crypto taxes
Filing cryptocurrency taxes isn’t a choice; it’s an obligation that every individual and business has. Those who keep track of their transactions — including the prices of the cryptocurrencies they transact — will have an easier time reporting their activities.
Even those who haven’t received any tax documents associated with their cryptocurrency movements may have taxable events to report. Speaking to Cointelegraph, Lawrence Zlatkin, vice president of tax at Nasdaq-listed cryptocurrency exchange Coinbase, said:
“Crypto assets are treated as property for U.S. tax purposes, and taxpayers should report gains and losses when there is a sale, exchange, or change in ownership (other than a gift). Merely HODLing or transfers of crypto between a taxpayer’s wallets are not taxable events.”
Zlatkin added that more advanced trading “where there is a change in economic ownership, literally or substantively, may be taxable,” even if the taxpayer doesn’t receive an IRS Form 1099, which refers to miscellaneous income.
Meanwhile, Danny Talwar, head of tax at crypto tax calculator Koinly, told Cointelegraph that investors can report cryptocurrency gains and losses through Form 8949 and Scheduled D of Form 1040.
Talwar said that investors with cryptocurrency losses after last year’s bear market might be able to save on current or future tax bills through tax loss harvesting.
Tax loss harvesting refers to the timely selling of securities at a loss in a bid to offset the amount of capital gains tax that would be payable on the sale of other assets at a profit. The strategy is used to offset short-term and long-term capital gains. Coinbase’s Zlatkin addressed this strategy, saying, “losses from sales or exchanges of crypto may result in capital losses which can be used to offset capital gains and, in limited circumstances for individuals, some ordinary income.”
Zlatkin added that losses “may not have been sufficiently crystallized from pending and unresolved bankruptcy or fraud,” adding:
“Taxpayers should be careful in how they treat losses and also consider the possibility of theft or fraud losses when the facts support these claims.”
He said that crypto investors should consult their tax advisers regarding any available tax breaks or deductions. Investors should also be aware of losses from “wash sales,” which Zlatkin described as “sales of crypto at a loss followed soon thereafter by the repurchase of the same type of crypto.”
Speaking to Cointelegraph, David Kemmerer from cryptocurrency tax software company CoinLedger, said that losses realized in 2022 can be an “opportunity” to reduce a tax bill, with capital losses offsetting capital gains and up to $3,000 of income per year.
David Kemmerer added that it’s “important to remember that exchange and blockchain gas fees come with tax benefits,” as fees “directly related to acquiring cryptocurrency can be added to the cost basis for the asset.”
He added that fees related to disposing of a cryptocurrency could be subtracted from the proceeds to help reduce capital gains taxes.
While the IRS has somewhat clear guidance on taxes owed from buying and selling cryptocurrency, tax forms for those involved in the sector can get more complex if they delve deep into, for example, the world of decentralized finance (DeFi).
Tax complexities with DeFi, staking and forks
Using DeFi can be complex, with some strategies involving multiple protocols to maximize yield. Between cryptocurrency-backed loans, transactions involving liquidity provider tokens and airdrops, it’s easy to lose track.
According to Coinbase’s Zlatkin, “most forms” of cryptocurrency rewards or yield are subject to U.S. tax when received.
He said that current U.S. laws on staking income are “undeveloped,” with the IRS treating staking rewards as “giving rise to taxable income when an individual taxpayer receives staking rewards over which the taxpayer has ‘dominion and control,’ or basically when the asset can be monetized.”
When it comes to airdrops and forks, CoinLedger’s Kemmerer noted that income from cryptocurrency forks and airdrops is subject to income tax, just like income from any other job. He said that when a fork or an airdrop lead to new cryptocurrency being earned, investors “recognize ordinary income based on the fair market value” of that crypto at the time of receipt.
Cryptocurrencies, nevertheless, go beyond these use cases. Many use crypto debit cards in their day-to-day lives, which means that in the eyes of the U.S. government, they’re paying for goods and services using property. What happens when it’s time to tell the IRS?
Tax implications of using crypto for payments
While defining cryptocurrency payments as property transactions sounds like a complex ordeal, according to Kemmerer, using crypto as a payment method is “considered a taxable disposal, just like selling your crypto or trading your crypto for another cryptocurrency.” He added:
“If you use your cryptocurrency to make a purchase, you’ll incur a capital gain or loss depending on how the price of your crypto has changed since you originally received it. “
Coinbase’s Zlatkin said this is true “even if the transaction is small, like buying a cup of coffee or a pizza.” If a payment is taxable when made with cash, it remains taxable with crypto, he added, stating:
“Furthermore, the recipient is generally treated as if they received money in the transaction and subsequently purchased the cryptocurrency with that money, and they are taxed accordingly.”
At this point, it’s clear that filing taxes related to cryptocurrency transactions is a complex process that needs to be well thought out. Cryptocurrency users need to consider all of this and avoid common pitfalls.
Keeping records is vital
Tax experts have repeatedly stressed that keeping records of every cryptocurrency transaction is key to avoiding incidents with the IRS. CoinLedger’s Kemmerer noted that without accurate records, “it can be difficult to calculate capital gains and losses.”
He added that records should include the date that users originally received their cryptocurrency and the date they disposed of it. This should be accompanied by the cryptocurrency’s price at the time of receipt and disposal.
Koinly’s Talwar told Cointelegraph that it’s “often easy to miss the number of taxable events which may occur during the year” because acquiring and spending cryptocurrency is “becoming more accessible than ever, with exchanges and products providing seamless user interfaces.” Talwar added:
“It is easy to misunderstand when a taxing point arises for crypto. Many people don’t realize that their staking rewards are taxed as income when received, even if they haven’t sold the underlying staked asset.”
Talwar advised those heavily involved in cryptocurrency to consult a tax professional during tax season to help them figure everything out.
Filing crypto taxes can be daunting for many, adding a new layer of complexity to an already hard-to-grasp sector that’s constantly evolving. Offsetting tax bills with potential losses can incentivize sophisticated investors to take risks in the space, as even their losses can help reduce their tax burden.
As the law is still unclear regarding some of the cryptocurrency sector’s more complex operations, those who prefer to avoid risks and stay on regulators’ good side should consider avoiding DeFi. Either way, consulting with a professional is less expensive and less stressful than dealing with fines and enforcement actions from tax authorities.
This article does not contain tax reporting advice or recommendations. Readers should conduct their own research and consult a professional when filing taxes on their investments and holdings.
