Cryptocurrencies are digital assets that can be used to make payments for goods and services, but many investors treat them like stock shares. In recent years, interest in cryptocurrencies has skyrocketed. Its popularity stems from the fact that it is a decentralized medium of exchange, which means it operates without the assistance of banks, financial institutions, or other central organizations such as governments.
In recent years, the IRS has increased its scrutiny of cryptocurrency transactions. As a result, you must keep track of your cryptocurrency transactions and report them to the IRS using the appropriate tax forms. Understanding the tax implications of cryptocurrencies is crucial whether you accept or use them for payment, invested in them, are a seasoned currency trader, or simply received a small amount as a gift.
How is cryptocurrency taxed?
The IRS treats cryptocurrency as property for federal tax purposes. It is considered an investment similar to real estate, stocks, or bonds, which are all capital assets. When selling a capital asset, you pay either short-term or long-term capital gains tax on the realized profits. The capital gains tax rate applied depends on the length of time the cryptocurrency was held and your income.
- Short-term capital gains tax. If you have owned the cryptocurrency for a year or less, any profits are usually considered short-term capital gains and are taxed at your ordinary income rate ranging from 10%-37%.
- Long-term capital gains tax. If you held the cryptocurrency for more than a year, any profits are usually considered long-term capital gains and are taxed at long-term capital gains tax rates of 0%, 15%, or 20%.
When does a cryptocurrency transaction trigger capital gains tax?
A cryptocurrency transaction that results in a realized gain can trigger capital gains tax, such as:
- Selling cryptocurrency for fiat currency.
- Trading one cryptocurrency for another cryptocurrency.
- Receiving goods or services in exchange for cryptocurrency.
- Receiving cryptocurrency as payment for goods or services.
- Mining for a cryptocurrency (the mined coin’s fair market value on the day it was mined is taxable income)
How do I determine cryptocurrency gains or losses?
Whether a cryptocurrency transaction results in a gain or a loss depends on the unit’s cost basis and value at the time of disposal.
Cryptocurrency is disposed of when it is sold, traded, or used as a form of payment. The cost basis is the whole cost of acquiring your cryptocurrency; this includes the purchase price, the value of the cryptocurrency you gave up to get it, or the amount reported as income if the cryptocurrency was earned.
- The taxable gain on the sale of the cryptocurrency is the difference between the cost basis and the values of the cryptocurrency at the time of disposal.
Cryptocurrency transactions must be disclosed on Form 8949 of your tax return regardless of whether they resulted in a gain or loss.
What accounting method can be used to determine gains or losses?
First-in-first-out (FIFO), Last-in-first-out (LIFO), and Highest-in-first-out (HIFO) are three accounting methods used to figure out cryptocurrency gains and losses.
- FIFO. When using first-in-first-out, the first coin you buy is also the first coin to be recorded as a sale.
- LIFO. With the last-in-first-out method, the last coins you buy will be the first ones you sell.
- HIFO. You sell the coins with the greatest cost basis (original purchase price) first when using the highest-in, first-out (HIFO) method.
Most investors use FIFO since it is the most conservative accounting method. However, you can only use HIFO and LIFO if you’ve kept meticulous records of all of your cryptocurrency transactions. If you have records with the following data, you can utilize a special identification method like LIFO or HIFO:
- The date and time each unit was purchased.
- Your basis and each unit’s fair market value at the moment of purchase.
- The date and time each unit was sold, exchanged, or otherwise disposed of.
- The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.
How to Use Cryptocurrency Tax Software
With the help of cryptocurrency tax software, you can keep track of each of these transactions, ensuring you have a comprehensive list of activities to report when it comes time to prepare your taxes.
The crypto tax software can reconcile your cryptocurrency gains and losses. Even though a lot of them claim that they calculate your “crypto taxes,” this is incorrect. In reality, these platforms gather all of your cryptocurrency transactions from multiple sources and compute gains and losses in US dollars per IRS guidelines. Therefore, the amount of taxes you owe on cryptocurrency gains is determined by your tax return.
The software must be linked to your exchange or wallet account. After that, the software will automatically track all of your transactions, including buying, selling, trading, and accepting cryptocurrencies as payment,and compute capital gains and losses. The information is then displayed on Form 8949, which is generated by the software. This can then be given to your tax preparer to complete your tax filing.
Here are examples of popular crypto tax software:
Given the variety of options, the following is a list of factors you should consider while picking a crypto tax software program for the 2022 tax filing season:
- Integrations. Support for all or most cryptocurrency exchanges; automated synchronization or integration with cryptocurrency exchanges to gather data necessary to determine your tax liability.
- Pricing. If you meet the requirements, be sure to take advantage of platforms that provide a free account. Be prepared to pay more if you have numerous transactions.
- Credibility. It is critical to verify the software’s credibility and legitimacy. After all, you will be held liable for the amounts reported on your tax return, so you should exercise caution when selecting a software provider.
- Reporting. Software provides cryptocurrency tax reporting. In addition to generating form 8949, crypto tax software providers may provide additional reports and services.
- Tracking. Tracking the history of your cryptocurrency transactions while calculating your gains and losses.
- Another useful feature offered by some platforms is the ability to invite your accountant to review your account without disclosing your own username and password.
How to Report Cryptocurrency on Tax Return
Cryptocurrency gains and losses must be reported on Form 8949 and Schedule D, and your cryptocurrency income on Schedule 1 or Schedule C. All of these forms must be attached to your Individual Income Tax Return Form 1040 by April 15th, 2023.
Partner with a Trusted Tax Accountant at Eco-Tax
Need help with cryptocurrency compliance? We at Eco-Tax are ready to assist you with cryptocurrency tax planning and reporting. To learn more about how we can help you, contact us today to book a free consultation with one of our trusted advisors. We look forward to partnering with you!