'You’re Likely to Get Caught': What Crypto Investors Should Know While Filing Taxes This Year
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The sweetest champagne can bring the heaviest hangover, and the biggest windfalls often bring the heaviest tax burdens.
For anyone who sold or traded dogecoin, ether, bitcoin or other cryptos last year, this tax season is going to be a headache. Cryptocurrencies are taxed as intangible assets, much like stocks or bonds. If you sell any cryptocurrency, exchange it for another crypto or even use it to buy something, you must report the transaction to the IRS — and you could be facing a huge tax bill.
Some people might assume that the anonymous nature of cryptocurrency means their activity would be invisible. Unfortunately for them, the Internal Revenue Service has X-Ray goggles.
Elliott Brack, managing director of tax services at Los Angeles financial advisory Manhattan West, said the personalized 1099 forms available for download at some crypto-trading platforms are also provided to the IRS. Although crypto exchanges won't actually be required to report transactions to the IRS via 1099 forms until 2023, the agency has other means of tax estimation too.
“I just want to highlight: yes, you really need to report your crypto transactions to the IRS,” said Blake Harris, an attorney who specializes in advising cryptocurrency owners on trusts and estates. “It’s built on the blockchain, which keeps a permanent record of all transactions. If you’re not reporting, you’re likely to get caught.”
The largely unregulated nature of crypto markets means that tax reporting has long been a user-generated activity. Crypto sites are improving their tax-tracking data, but the burden of reporting still lies on the user.
Money has published a full guide for how crypto is taxed you can check out, but the central question to address at tax time is simply: How much do I owe? To answer that, you must be able to track the cost basis and nail down how much you earned in capital gains from trading crypto.
Crypto taxes: How to track the cost basis
Cost basis is the original price you paid for the asset. The IRS levies taxes based on the capital gain, which is the increase in price from the cost basis to the price on the date of sale.
Traditionally, crypto trading sites have not been good at tracking cost basis, said Brack, of Manhattan West, and it’s worth keeping your own set of records. Some crypto trading venues, including Robinhood, make 1099 forms with a cost-basis estimate available for download if you have sold crypto during the tax year, but that’s a rare practice.
Coinbase provides an annual gain/loss estimate to users, but the company warns that the data will only generate reliable cost-basis information if all of your crypto trading was conducted on its exchange. If you moved your crypto wallet over from another exchange, the Coinbase data will not account for that. The same is true of transaction-tracking options at Binance.US.
It's worth noting that neither of these popular crypto exchanges currently send the gain/loss data to the IRS, so the numbers are unofficial. (Coinbase does issue IRS forms to select customers, but only if they meet certain criteria outside of basic buying and selling crypto on the platform.)
Also, if you trade on an automated, decentralized exchange like Uniswap or an overseas exchange, there are no 1099s or cost-basis estimates of any kind, said Vik Sasi, managing director for digital assets at Manhattan West.
One website, CoinTracker.io, computes cost basis for people who have moved wallets or traded crypto on multiple exchanges. CoinTracker's services range from $0 to $199 for most users, depending on how many transactions you need tracked per year. Coinbase offers some of its users a discount for CoinTracker.
Depending on what kind of tax software you use when filing, it may not be all that difficult to figure out how much you owe the IRS. TurboTax, for example, has partnerships with platforms like Coinbase and Robinhood that can automatically import thousands of crypto transactions at once.
If the IRS discovers that you incorrectly stated your cost basis during an audit, it could mean that you owe extra taxes. For this reason, it’s essential to keep detailed records of your own about the prices and times of crypto purchases and sales.
If records are confusing and there’s a lot of money at stake, it might be time to call in a professional accountant. For assets that have been gradually accumulated, a pro will be able to assess cost basis using the more favorable “last in, first out” or “highest in, first out” methods than the default “first in, first out” method applied by the IRS, said Brack.
How to lower or avoid crypto taxes
There are strategies to help minimize how much you pay in taxes from crypto trading, and not everyone who owns cryptocurrency will owe money.
The tax code rewards those who “HODL” — hold on for dear life — their cryptocurrencies rather than selling them for quick easy profits. One of the most fundamental factors in determining your tax burden is the length of time you held the cryptocurrency, Nate Hansen, founder of online accountancy firm SuperfastCPA, noted in an e-mail.
If you sold the crypto after owning it for less than a year, you are subject to short-term capital gains taxes, which range from 22% to 37%. Long-term capital gains taxes are in the less painful range of 0% to 20%, depending on your income bracket.
“For investors able to hang on and hold on for more than a year and survive the dips, it definitely can provide a nice tax windfall when they sell,” said Brack, of Manhattan West.
One reason that the IRS treats the income generated so differently is that short-term trading is viewed as an occupation, while holding is investment.
Finally, while the IRS taketh away, it also giveth. If you have a loss on one or more cryptocurrency investments, and are facing a high tax bill for other reasons, you can tactically sell to offset the tax burden. It's too late to do so for the 2021 tax year, but the strategy is worth considering towards the end of 2022.
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