Yes, it’s true. Tax time is right around the corner. And for those of you who own cryptocurrency coins/tokens, it’s extra-special. That’s because investing in cryptocurrency is a recent phenomenon – fewer than 10 years old – and presents some interesting tax issues. This post will give an overview of crypto taxation, and then help you get prepared for calculating your gains/losses in 2018. Of course, I can help you with your crypto tax situation, through my firm KTT Global Advisors, LLC.When it comes to crypto taxation, there are two types of people. People who have reported crypto tax gains/losses, and those who haven’t. Within the second group are those who never plan to report crypto gains/losses. This post is not for them.
Let’s Start with the Basics. The IRS, in 2014, issued its ONLY guidance on taxation of cryptocurrency. In brief, the IRS stated:
Cryptocurrency is property, and is taxed accordingly (capital gains/losses)
Cryptocurrency is NOT similar to foreign currency w.r.t. U.S. taxation (I.R.C. Sec 988), e.g. “de minimus” gains excludable from income, and treatment of gains and losses as ordinary vs. capital
Crypto received as compensation for services is taxable as income
Mining income is treated like any other income from a business or hobby
Here are some questions that were NOT specifically answered by the guidance:
Are crypto-crypto trades taxable events? Can I apply I.R.C. Section 1031 “like-kind exchange” rules?
What inventory valuation method should be used when calculating gains and losses on crypto transactions? LIFO? FIFO?
How do I calculate the basis for tokens received by way of an air drop or a hard fork? (see my thoughts here)
So where does that leave us at the end of 2018? Not that much better off, from a guidance perspective. In fact, in September a group of congressmen sent a letter to the acting IRS commissioner urging him to provide more guidance on the taxation of crypto.However, unless you are really trying to do something aggressive from a tax perspective, you have all the guidance you need. On the most debated pre-2018 crypto tax issue, the applicability Sec 1031 “like kind exchange” rules, I do not believe that applying them to crypto-crypto trades is valid. Actual IRS guidance from this period specifically excludes “stocks, bonds, or notes” from Sec 1031 treatment. As crypto’s closest tax relative is stock, it’s no stretch to apply the same rules.As a far cost basis for gains/loss calculations, another crypto tax discussion item, let’s approach the issue by looking at two populations:
People Who Have Reported Crypto Gains/Losses Before. If you have reported your gains or losses on crypto transactions before, then chances are that you have used one of the available on-line tools specifically designed for the purpose, such as bitcoin.tax or CryptoTrader.tax. In doing so, you have chosen an inventory valuation method, likely first-in-first-out (FIFO) or last-in-first-out (LIFO). Each method refers to an assumption about what asset is being sold; in the case of FIFO it would be the first asset purchased that is remaining in inventory. In an environment of fluctuating prices, the decision to use one or the other inventory valuation method can have a significant impact on reported gains and losses.If you have used a particular method in prior years, it’s easier to keep using that method. You can switch between methods, but it requires your having your trades tracked accurately.
If You Have Never Reported, then you need to start by doing an inventory of all of the exchanges where you traded. Because cash-to-crypto and crypto-crypto trades are taxable, any gain/loss calculator is primarily going to look at trading activity. Additionally, mining, gift, crypto-for-services, and spending activity will need to be brought into the mix, resulting in a current inventory of crypto tokens. This end result can then be compared to any online (cointracking.info) or offline (spreadsheet, scrap of paper) tool that you used to keep track of your portfolio, for accuracy.Once you have an accurate picture of your portfolio, then you can proceed with the gain/loss calculations discussed above. Crypto tax applications generally have good reporting functionality, allowing you to export Form 8949 (trade data) in either PDF form that resembles the actual IRS document or in CSV format. I prefer the latter when there is significant trading activity.
Miners! For most miners, mining income is akin to “hobby” income from an IRS perspective. This means that the value of any coins or tokens that are mined (based on the price of the coin/token on day of receipt) is income, which can be offset by expenses (e.g. 3rd party mining contracts) up to the amount of income earned. If you are doing mining as a business, then you have a slightly more complicated situation from a reporting perspective – you need to report business income and expenses, likely through Schedule C.
Take Advantage of Your Losses. Because 2018 has been a down year for crypto, it’s possible that you have realized losses or have significant unrealized losses in your portfolio. This is where the practice of “tax loss harvesting” can be beneficial:
Gains earlier in the year can be offset by taking losses at the end of the year
Realized losses can offset other capital gains – property, equities, etc.
Strategically offsetting gains with losses can result in generating tax-free cash from your portfolio. This does not mean that the returns are positive, mind you.
Pay attention to long-term vs. short-term gains and losses
$3,000 in losses can be carried through to the main tax form 1040, offsetting ordinary income.
Note that losses in excess of $3,000 can be carried forward indefinitely and can be used in future years (sadly gains can not be deferred) but I do not recommend “locking in” losses as some have suggested
A CPA can help you work through these scenarios
The time to organize your crypto data to be ready for tax reporting is NOW. I’ve worked with several clients who have performed the task over the past few months, and it’s never as easy as one originally thinks. Plus, if you approach your CPA in March 2019 looking for her to make sense of five years of trading, you’re likely to get a significantly higher price quote than you would now.
->The Blockchain CFO