Here’s what you need to know if you’re in the US
The time to give Uncle Sam his cut of your cryptographer is fast approaching – and just like in years past, there are still plenty of unanswered questions and gray areas to tread with caution if you’re in the US
And if you’ve done more than a few small trades, with professional help.
There are a couple of reasons for this – the two biggest being that the process of figuring out how much you owe in crypto taxes can be hugely complex, and that the Internal Revenue Service has gotten more and more serious about cryptocurrencies.
How serious? The very first question on this year’s Form 1040 – which is right below your name and address, and above whether you can claim the standard deduction – is whether you have owned digital assets. It says:
And if you think that the pseudonymity of Bitcoin and other cryptocurrencies will somehow shield you, be aware that the IRS requires centralized exchanges that transact client data to file a 1099-K form for anyone who has made more than 200 transactions and trades worth $20,000 during the year.
Despite that, “the IRS has still provided very little guidance on cryptocurrency taxation,” Andrew Gordon, managing partner of crypto-focused Gordon Law Group, told CoinMarketCap. “It’s not always as unclear as people think it is because there’s usually a way to apply the tax code to the facts, but there’s a lot of legal gray area.”
That said, some aspects of crypto don’t fit in very well, Sharon Yip, a CPA and co-founder of Polygon Advisory Group, told CoinMarketCap.
“People are still not sure what the correct tax treatment is for complicated transactions like liquidity pools, yield farming, rebase tokens, [and] self-paying loans,” she said.
It will only get worse, Yip added, noting that “new and complicated crypto products and activities are being created at a rapid pace, especially in the DeFi and NFT spaces.”
Despite that, Gordon, a lawyer and certified public accountant who has been focused on crypto-tax since 2014, warned:
Much of this uncertainty is due to Congress rather than the IRS, according to Pat Larsen, co-founder and CEO of crypto accounting software firm ZenLedger.
“In general, a big issue like ‘what is the tax and regulatory framework for cryptocurrency’ is meant to be addressed by lawmakers,” and allow the IRS and other regulators to enforce those laws, Larsen told CoinMarketCap. “This hasn’t happened in crypto in the US yet.”
With that in mind, here’s a look at some of the most important things crypto holders need to know — and things they need to know they don’t know — heading into tax season.
The first and most important of the settled issues is that the IRS generally considers cryptocurrencies to be property for tax purposes.
This means that most crypto-related activities are subject to capital gains tax. Which is a far bigger problem than it sounds.
“It can get very complicated because every time you use, exchange, trade or convert crypto and NFTs, it’s a taxable event,” Gordon said. “You can ‘spend’ a small fraction of a token, but you need to know the cost basis and acquisition date of that fraction.
The cost basis is the price at which you purchased the relevant token or fraction of a token, and is compared to the price at which it is sold to determine a gain or loss.
The acquisition date is important because it determines the tax rate you will pay. Long-term gains are those held for more than one year, and are taxed at 0%, 15% or 20%, depending on income. However, short-term gains are taxed at seven brackets starting at 10% and rising to 37%.
So whenever possible you want to use the oldest crypto in your wallet or HODL it a little longer.
“An important tip everyone should know is that you have to report crypto even if you lost money,” Gordon said. “A lot of investors don’t get that.”
In addition to tracking capital losses to offset capital gains, he added, they can be used to offset up to $3,000 in ordinary income.
There are four methods to calculate the cost basis of your crypto transactions. These are:
“The process of calculating capital gains and losses for individuals with a high volume of trades can be incredibly complex and sometimes almost impossible to do on your own, depending on your trading history,” Larsen said. He added:
That’s where tax software like ZenLedger comes in, importing data from multiple wallets and exchanges to determine profits and losses, he added.
Even with good software, the process can include manually verifying some transactions – especially complex ones or those marked as missing – or adding transactions from platforms that don’t offer downloadable data.
Frequent traders, Gordon said, “may have thousands of transactions to look at. Usually that’s when people call us.”
Correct buying and selling of crypto is not the only thing the tax authorities want to know about.
A notable capital gains taxable action is exchanging one digital asset for another — such as buying dogecoin with ether, the Kraken exchange said in a recent blog. This includes stablecoins and NFTs.
Another is to sell or use digital assets to pay directly for goods or services. This has become a problem when using cryptocurrencies like Bitcoin for everyday purchases, payment processors acknowledge, since even buying a can of Coke would trigger a capital gain. Several of the crypto regulatory proposals proposed last year included a purchase threshold of $50 to $200, below which capital gains would not be triggered.
Then there is crypto created in a hard fork – for example, when the Bitcoin holdings were duplicated on the Bitcoin Cash blockchain.
And sales of digital assets for fiat, including metaverse items or “land” must be reported.
Then there are sources of taxable income that must be stated. These include:
Things that do not trigger capital gains include:
Kraken added that unlocking digital assets in staking contracts does not trigger capital gains, although any income from it does, which is kind of splitting hairs.
One strategy for crypto gains that may be coming to an end, Larsen said, is tax loss harvesting. That means selling crypto holdings that have lost value to realize the loss and offset capital gains made elsewhere, then buying it back to preserve the portfolio’s desired holdings.
In the securities industry, the wash sale rule applies for 30 days.
Under newly proposed rules, he said, “the wash sale rule would apply to crypto, therefore removing the current ability to sell and immediately buy back.”
On March 21, the IRS and US Treasury published a notice announcing their intention to treat many non-fungible tokens as collectibles — which are “generally taxed at rates other than securities or income,” Larsen said.
These rates are generally less favorable than the capital gains on other assets, the agency said.
While seeking comment on the new rules, the IRS notice advised using a “transparency analysis.”
This means that if the item in the NFT is a collectible, so is the NFT. The agency gives an example of an NFT that certifies ownership rights to a pearl. As gems are collectibles, so are NFTs.
“If an NFT has a visual component — like unique or serialized artwork — then it’s likely to be a collectible,” Larsen said. The same would not be true for NFTs that give titles to metaverse “land” plots.
One of the hardest questions to answer is what people who had funds frozen and lost on failed platforms like Sam Bankman-Fried’s FTX exchange or crypto lender Celsius should do.
Tough enough that Gordon said “we advise most clients to file an extension and wait to see if the IRS will provide any guidance on this specific situation, because it affects many taxpayers.”
The problem is that while lost funds and assets may result in a capital loss, while the bankruptcies are still playing out, it is not at all clear how much affected customers will get back or when they will get it.
“If you end up getting any of your money back from Celsius, FTX or BlockFi, it will be ordinary income at the time of receipt,” Gordon said. He added:
This was already playing out with clients from the famously hacked and bankrupt Mt Gox exchange, Larsen said.
