While the world of cryptocurrencies has exploded in recent years, taxes continue to be a headache for many investors. As governments pay closer attention to these assets and decide how to tax them, folks must stay up to date with the most recent news, and tax laws.
My friend David Kemmerer, Co-founder and CEO of CryptoTrader.Tax, and I recently sat down to talk about cryptocurrencies and the tax implications of these investments.
1. How are cryptocurrencies like bitcoin treated from a tax perspective?
Contrary to what their name suggests, cryptocurrencies like bitcoin are treated as property by the IRS, not as currency.
What this means is that the same capital gains and capital losses tax reporting rules that apply to other forms of property like stocks, bonds, and real estate also apply to cryptocurrencies.
For example, if you bought $500 worth of bitcoin and sold it a few months later for $750, you would incur a $250 capital gain. This capital gain is a form of income that will be reported on your taxes.
2. Are there any ways for investors to be reducing their crypto tax liability?
There are many ways for cryptocurrency investors to reduce or, in some cases, eliminate their cryptocurrency tax liability.
While capital gains from crypto investments lead to a form of taxable income, capital losses reduce your taxes—i.e., they reduce your taxable income.
Using the earlier example, let's say instead of selling your bitcoin for $750, you sold it for $300. This sale of your bitcoin realizes a $200 capital loss. This loss gets reported on your taxes, and it reduces your taxable income for the year by $200.
Given this treatment, one of the most effective ways for crypto investors to reduce their cryptocurrency tax bill is to engage in tax-loss harvesting. This is the act of selling or trading cryptocurrencies that have gone down in value to realize a capital loss. In the cryptocurrency markets that we have experienced over the last couple of years, there are plenty of opportunities for investors to harvest losses. Crypto tax calculators have built-in tax-loss harvesting tools to help investors identify which assets in a given portfolio present the best tax-loss harvesting opportunities.
Other ways investors can reduce their cryptocurrency tax liability include making charitable contributions with their cryptocurrency, moving crypto assets into a tax-advantaged retirement account like an IRA or 401K, or investing capital gains into a federal opportunity zone to defer tax payments.
3. Why can't cryptocurrency exchanges provide their users with accurate tax documents?
One of the biggest challenges within the world of cryptocurrency tax compliance stems from the fact that cryptocurrency exchanges themselves can't give specific capital gains and losses tax documents to their users.
This inability is a result of cryptocurrency being a transferable asset, i.e., you can send crypto from one wallet to another.
Because users can easily send bitcoin or other cryptocurrencies into the wallet of their preferred cryptocurrency exchange, the exchange themselves often doesn't have data on the original purchase price of an asset, or what's known in accounting terms as your cost basis (the amount that it cost the user to acquire a cryptocurrency). Without cost basis data for all assets, it's impossible to tell a user what his or her associated gain or loss is. Transfers of cryptocurrencies happen all the time, and as a result, exchanges themselves can't provide their users with capital gains and losses reports.
4. How are software platforms automating the cryptocurrency tax reporting process?
To address the fundamental tax problem that exists at the cryptocurrency exchange level, cryptocurrency tax software tools that aggregate transaction and cost basis data across a variety of exchanges and wallets have emerged.
Cryptocurrency tax software works by allowing users to import all of their historical cryptocurrency transactions—buys, sells, trades, and earned coins—into one unified system of record. To do this, they integrate with major cryptocurrency exchanges, wallets, and native crypto platforms. These integrations allow a user to seamlessly pull in his or her historical trade data into the software with the click of a button. Once a user has pulled in their transaction history from all of his or her exchanges and other crypto platforms, tax reports based on this data can be generated with the click of a button.
Thank you to David for the lesson in crypto taxes. It's comforting to know that there are people like you guys that are working on the tax issues that the cryptocurrency space raises.
Learn more in The Rocket Dollar Guide to Self-Directed Retirement Plans