This is a guest post submitted on CryptoTapas.
With the endless opportunities and fresh excitement revolving around cryptocurrency, it can be easy for crypto investors to forget about the cold reality of taxation. Bitcoin and other cryptocurrencies have become so popular that, inevitably, governments around the world have begun paying more attention to these assets.
As such, taxpayers should strive to stay on the good side of the IRS instead of being reactionary. The tax body may actually be quite lenient on taxpayers that are honest about their mistakes, especially when those mistakes are small. And this honesty could be the difference between forgiveness and paying interest and criminal penalties.
The IRS Is Watching You!
Unfortunately, the IRS has given little guidance regarding crypto taxation up to this date. The first and only solid IRS guidance was released in 2014. One thing that has always been clear, however, is that while crypto investors refer to their crypto as ‘currency’ (as the name would suggest), the IRS treats it as property for taxation purposes. This means that engaging in any activity involving spending, exchanging, or even selling crypto will have a capital gain impact. On the flip side, crypto received as compensation will be deemed ordinary income.
While many crypto taxpayers struggle to comprehend the exact implications that come with purchasing assets using virtual currencies, hard forks, exchanging cryptocurrencies, airdrops, etc. No matter whether they are investors or dealers, a basic requirement is to file Forms 8949. 2017 saw a change to section 1031, which was included in the 2017 Tax Cuts and Jobs Act (TCJA). This modification gave the IRS more power to pursue taxpayers that have invested in this field.
Moreover, a change in the tax code in 2018 saw the elimination of like-kind crypto exchanges for the non-real estate transactions being included. As a result, crypto traders will no longer be able to maintain that their crypto-to-crypto trades are non-taxable as per Section 1031. You are therefore advised to be cautious when you make crypto trades. Let’s look at some specific crypto transactions and their accompanying tax implications:
- Trading Crypto Currencies – Trading with crypto generates either capital losses or gains. The IRS stipulates that the former can offset your gains and, as a result, reduce tax.
- Exchanging – In the exchange of one token for another, you are creating taxable income that the IRS recognizes. An example of such an exchange would be to use Bitcoin in the purchase of Ethereum. The IRS considers the token sold and thus capital gains or losses are generated.
- Payments in Crypto – If you get paid in crypto for your products or services, the salary you earn is treated as ordinary income. This will be at the fair market value of the specific coin at the time of receipt.
- Spending Crypto – sending your coins is considered to be a taxable event as you end up creating capital gains or losses, which could be either long term or short term. One example is when you acquire a coin for $500. If the coin ends up being worth $1000 and you purchase a $1000 gift card, that means a $500 taxable gain exists.
- Conversion and Air Drops – Converting crypto to any other currency at a gain constitutes a taxable event too. Moreover, airdrops will typically be considered ordinary income on the material day of the airdrop. The value automatically forms the basis of the coin and selling or exchanging it generates a capital gain.u
How Can I Make My Crypto-Life Easier?
2019 is the perfect year to start afresh on your crypto-investing activities. Numerous crypto accountants these days can utilize strategies such as specific identification of specific coins, which allows taxpayers to manage both their long-term and short-term capital gains. However, wallets and exchanges are yet to be clear on which coins to exchange or sell. With that in mind, the following tips will make life easier when tax time arrives.
- Limiting Number of Exchanges – Approximately 200 exchanges support active crypto trading in the United States. In this case, crypto taxpayers are advised to collapse their trading activities to one or two exchanges. This way, it will be far easier to keep track of all your transactions, and you can readily present the reports when you need to.
- Avoid Margin Trading – Many crypto exchanges allow investors to use margin trading to leverage different positions. However, it comes with numerous, potentially costly, risks, such as having all your holdings wiped out. Taking care of your margin trading will require being deliberate in all your actions. As such, it is best to create a separate account for margin trading activity, which will facilitate accuracy.
How Do I Figure Out All These Capital Gains and Paperwork?
In each trade you undertake in the crypto space, you should recognize the cost basis. This is the original value of the crypto. Moreover, it is critical to understand the fair market value of the crypto coins at the time of trading. After discovering these two aspects, you can then calculate your capital gains or losses by simply subtracting the cost basis from the current fair market value. The next step primarily involves filling out the proper forms for the IRS.
Form 8949 and 1040 Schedule D
Schedule D is a form used in the reporting of capital gains or losses generated from personal property. This includes assets such as collectibles, cars, stocks, and cryptocurrency. However, before you fill out this form, all your trading activities should be reported via Form 8949. After completing Form 8949, you are only required to transfer the sum of capital gains or losses to the Schedule D form. This is typically the last step in the reporting process.
In terms of Foreign Bank Account Reporting (FBAR), a recent FinCEN update stated that cryptocurrencies are not subject to these filing requirements. This update was made in response to a specific request regarding guidance from an accountant’s group. However, the Foreign Account Tax Compliance Act (FATCA) requires crypto that is held, stored or even maintained in offshore accounts to be reported in the first section of Form 8938. However, your best bet is always to consult an expert crypto accountant, as IRS regulations are subject to change at any time, and you can be easily caught out. These regulations should also be reviewed with regards to each case presented too.
The tax season is often marred by stress and uncertainty, especially for crypto investors, so it is time for a little planning – and the above advice should help you do just that. This way, you will have less hassle as you try to file your taxes. Just recently, the IRS started sending out 10000 letters to crypto holders in a quest to oblige them to review or pay their tax dues. Do not wait for the IRS to come down on you; get everything in order now.
Thank you for reading this article.
About the Author:
This is a guest post by Mike Scotti. Mike is a freelance contributor and writer at Koinly.io – a cryptocurrency tax reporting solution. He is also a contributor at other popular publications.
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