If you managed to cash in on cryptocurrency last year, it’s now time to report those profits to Uncle Sam on your tax return.
Roughly $30 billion was poured into the crypto space in 2021, and about $7.2 billion came from the U.S.-based investors, according to Pitchbook data cited by Bloomberg. The vast amount of wealth that cryptocurrencies have generated in the past year quadrupled from its 2020 year-end value — hitting nearly $3 trillion. While the value of cryptocurrency doesn’t come close to other asset classes that have been trading on international markets for decades, it has no doubt gone mainstream — attracting the attention of seasoned investors to novice investors, not to mention the IRS.
“The IRS is starting to do more data gathering so that should get people thinking about ‘What have I done with crypto’?” Anjali Jariwala, founder of Fit Advisors, a financial planning, investment management and tax planning firm, told Finurah.
When you sell crypto, you pay taxes on earned income, otherwise known as capital gains, not on the money for which you initially purchased. The IRS is providing guidance on basis calculation, which is essentially “when you sell crypto, you have to [subtract] from the original cost and that’s your gain,” explained Jariwala.
The 1040 Tax Question
Well-aware of crypto’s big year, the IRS is putting it on top of its agenda. This year, the agency moved up the question on the 1040 form about whether you’ve sold, exchanged or “disposed of any financial interest in virtual currency.” Regulation of cryptocurrency has been an increasingly pressing issue for the U.S. government as President Biden stated in his executive order on “Ensuring Responsible Development of Digital Assets” in February. Oversight of digital assets becoming more integrated in the global financial system means investors will need to be more vigilant about keeping track of their crypto dealings.
For example, E. Martin Davidoff, Partner-in-Charge of National Tax Controversy at Prager Metis says, “Imagine if you’re buying 300 cups of Starbucks coffee a year – that’s 300 transactions to report, so accounting for it is a nightmare. There is software to make it easier but that is every time you use cryptocurrency.”
Treated Like ‘Property’
Cryptocurrency holdings are treated like “property” for tax purposes and therefore are taxed like any other asset, such as stocks or real estate. It’s important to note that simply purchasing a type of cryptocurrency isn’t subject to taxes, albeit not yet.
While tax rules around cryptocurrency are still fairly nascent and evolving as regulation ramps up, here are some tips to keep in mind, as they may work to your advantage before you file your taxes this year.
Crypto Tax Filing Tips
1.Understand capital gains and crypto transactions: As of now, taxes for cryptocurrency are only applicable to people who’ve sold, spent or exchanged cryptocurrency for another digital asset that resulted in earned income, otherwise known as capital gains. Depending on how long you’ve held the digital asset, you’ll have to pay either a short-term or long-term gain taxes. Long-term gains are taxed at a lower rate than short-term gains. If earnings on your crypto accumulate for less than a year, you’ll have to pay a short-term gain; any duration longer than that results in a long-term gain tax.
For business owners, Davidoff cautions entrepreneurs to be aware of transaction dealings with cryptocurrency.
“Every time you use crypto in business, there are two transactions happening. There’s a sale and whatever else it is you do with the money, such as paying an accounting fee [for your business]” Davidoff told Finurah. “If you’re using crypto in your business and you accept crypto as income, the value at the time of income is income for tax purposes.”
2. Take advantage of tax-loss harvesting: Turning investment losses into tax breaks is the saving grace for investors. When investors use this strategy, they can sell cryptocurrency at a loss to help minimize the amount in capital gains they pay.
Cryptocurrencies are not subject to the “wash-sale” rule, unlike stocks. “What that means is when you sell crypto at a loss, you can quickly buy back the same coin and still get the benefit of that loss,” said Shehan Chandrasekera, CPA and Head of Strategy at CoinTracker. “If you were to do that in stocks you would have to wait at least 30 days before you buy back the same stock.”
Under the Wash-Sale Rule, if an investment is sold at a loss and then repurchased within 30 days, the initial loss cannot be claimed for tax purposes.
In order to take advantage of tax-loss harvesting, knowing your cost basis when you’ve bought the crypto and being vigilant by keeping a record of your transactions can result in tax savings
3. Hire a Certified Public Accountant or Certified Financial Planner: There is an endless amount of resources and expert commentary on how to self-report your crypto trades and transactions, yet the help of a merited financial professional can’t be understated when it comes to avoiding any tax reporting mishaps.
“If you have a large crypto balance, you want to work with a professional that has knowledge on this asset class,” said Jariwala. “This is becoming front and center so you don’t want to open yourself up to an IRS audit or huge penalties just because you didn’t know or didn’t have the right guidance.”
