Crypto Tax Reporting 101: A Guide to Reporting Transactions
Written By Jackson Frazier, Senior Tax Preparer at BEC CFO & CPA
In recent years, cryptocurrency transactions have faced increased scrutiny from the IRS. If you’ve entered the world of cryptocurrency, understanding how to report your gains and losses is essential. Tax season can be overwhelming, but a clear approach to handling crypto trades can save you time and money. Here’s a step-by-step guide to help you accurately report your cryptocurrency activity.
Step 1: Track Your Cost Basis
Your cost basis is the original value of your crypto holdings, which includes the purchase price plus any transaction fees.
Step 2: Identify Your Transactions
These events can trigger taxable gains or losses:
Conversions to USD: Selling cryptocurrency for fiat currency (e.g., US Dollars).
Trades for Other Cryptocurrencies: When using one cryptocurrency to purchase another, the gain or loss is calculated by subtracting your cost basis in the original crypto from the fair market value (FMV) of the new cryptocurrency at the time of the transaction. This is treated as a taxable event, as though you sold the original crypto for fiat and used that to buy the new crypto.
Purchases of Goods and Services: Using cryptocurrency to purchase goods or services is treated as a sale of the crypto for tax purposes. The gain or loss is the difference between the FMV of the acquired goods or services and your cost basis in the cryptocurrency. If the FMV of the item exceeds your cost basis, you have a taxable gain; if it is lower, you incur a loss.
Step 3: Choose Your Accounting Method
The accounting method you choose determines how your gains or losses are calculated:
FIFO (First-In, First-Out): The first crypto units you bought are the first units sold. This method assumes the oldest units are sold first.
LIFO (Last-In, First-Out): The most recently acquired crypto units are sold first. This method assumes the newest units are sold first.
HIFO (Highest-In, First-Out): The highest-cost units are sold first, potentially reducing taxable gains.
Step 4: Calculate Your Gains and Losses
Once your transactions are organized and your accounting method is selected, calculate your capital gains and losses by subtracting your cost basis from the sale or exchange value to determine the gain or loss for each transaction.
Critical Points
Real Estate and Crypto Strategies: A useful strategy for reducing taxable crypto gains is leveraging rental property depreciation losses. If you own rental properties, depreciation-related losses can offset your capital gains and potentially lower your overall tax liability.
Impact of Accounting Methods on Tax Treatment: Crypto sold after being held for less than 12 months is considered short-term and taxed at your ordinary income rate. Crypto held for more than 12 months qualifies for long-term capital gains rates (0%, 15%, or 20%, depending on your income). The accounting method you choose can affect whether you dispose of short-term or long-term holdings, so it’s important to consider holding periods when selecting your strategy.
Understanding Capital Gains Stacking: Capital gains from cryptocurrency are added on top of your ordinary taxable income to determine your capital gains tax rate. This calculation is done without applying the standard deduction, meaning your combined income could push you into a higher tax bracket for capital gains.
Additional Taxes to Consider:
State Taxes: Many states impose capital gains taxes in addition to federal taxes.
Net Investment Income Tax (NIIT): A 3.8% surtax that applies to individuals with high investment income.
Tracking Software
Manual Tracking: in a spreadsheet, include the following details for each transaction: date of transaction, type of transaction (buy, sell, trade), amount of crypto transacted, FMV of crypto at transaction date, fees paid, wallet/exchange used.
Automatic Tracking: Apps such as CoinTracking, CoinTracker, Koinly and ZenLedger can link to your digital wallets and track cost basis and calculate gain/loss on disposal of cryptocurrency.
Final Thoughts
Accurate crypto tax reporting is key to staying compliant and avoiding penalties. By tracking your transactions, choosing the right accounting method, and understanding your tax obligations, you can minimize your tax burden. If your crypto activities are complex or involve significant gains, consulting with a tax professional can help ensure you are filing correctly and taking advantage of any available deductions.