Hey gang, a few months ago my CPA buddy wrote up some info about taxes and crypto, I asked him if he’s ok with me sharing it and he said yes, so thanks to Sam for the following info:
*Note: This was written with US tax laws in mind. Always remember to seek professional help if you’re unsure, and it never hurts to get a second opinion as well.
How to handle your crypto taxes in 2021:
Step 1: Understand the tax implications of crypto
Step 2: Aggregate your transaction data across all your platforms
Step 3: Calculate your gains, losses, and income in USD
Step 4: Filling out your tax forms from your calculations
Understand the tax implications of Crypto
- Trading crypto to fiat currency is a taxable event
- Trading crypto to crypto is a taxable event
These activities are reported as capital gains/losses. Short term gains are taxed at ordinary income rates (10-37% depending on taxable income). Long term gains are taxed at long term capital gains rates (0-20% depending on taxable income)
- Mining income is taxed as ordinary income
- Staking income is taxed as ordinary income
- Interest income from lending crypto is taxed as ordinary income
These activities are all taxed at ordinary income rates (10-37% depending on taxable income)
Your personal income tax bracket and the holding period of your crypto assets will determine how much tax you pay. This will be different for each investor.
Aggregating your transaction data across all your platforms
- You can do this by hand or using spreadsheets, or
- You can use a crypto tax software
Some crypto tax software I like:
Crypto exchanges like Coinbase and Binance do not have the ability to provide their users with 100% accurate tax reports. This is because of the unique characteristics of crypto, namely the transferability. Most investors are frequently transferring crypto into and out of exchanges, and the exchange has no way of knowing how, when, where, or at what cost basis you originally acquired your crypto. They only see when your crypto appears or exits. This is why we need to make a good faith effort to use accurate estimates when reporting our crypto transactions for taxes.
Calculate your gains, losses, and income in USD
Fair market value - cost basis = capital gain/loss
Fair market value is the price an asset would sell for on the open market. This is the sale price in USD.
Cost basis represents how much money you put into purchasing your crypto (how much it cost you). Cost basis includes purchase price plus all other costs associated with purchasing your crypto.
**Filling out your tax forms from your calculations **
Capital gains and losses are reported on IRS form 8949.
Ordinary income from crypto is a bit more complex:
- if you earned crypto for performing services or running a crypto mining operation, the income is reported on Schedule C of your tax return.
- if you earned staking income or interest income from lending out your cyrpto, this income is reported on Schedule B of your tax return
These are NOT TAXABLE EVENTS:
- Buying and holding crypto
- Crypto Transfers from one exchange to another exchange or wallet
I know I’m going to get asked about avoiding taxes via not having to provide KYC or any identify verification. To my knowledge this is still possible by using certain exchanges and non KYC wallets. In my opinion, this will be regulated in the next few years and as a CPA, I always recommend using ethical practices when it comes to preparing your taxes.
Donating Crypto to a Qualified 501(c)(3)
There are so many amazing things going on in this space. One that is not discussed very often is using your appreciated cryptocurrency to both get a tax deduction and give to charity at the same time. How does it work? Donating your crypto directly to charity has two significant benefits, for both you and the charity:
- Your tax deduction will be equal to the fair market value of the donated crypto and you avoid the capital gains tax you would have paid if you sold the crypto before donating
- Your gift to charity will be larger because instead of selling and paying capital gains taxes, the 501(c)(3) charity will receive the full value of your donated crypto.
Here is an example:
Let’s say Bob purchased one bitcoin back in 2019 for $5000 and now he sells it in 2021 for $45,000. That is a $40,000 long term capital gain, subject to long term capital gains rates. Instead, Brian could donate the bitcoin to a qualified charity and receive two benefits. First, he would not owe any capital gains tax as a result of the donation. Second, he would reduce his federal income tax via itemized deductions and charitable giving.
I would not recommend this if you are in the 0% long term capital gains tax bracket as you could sell the crypto in question and pay no capital gains tax. However, for those in the 15% or 20% long term capital gain brackets, this is a strategy to avoid the capital gains tax and give to a good cause at the same time.
- Make sure you keep records to prove the amount of the charitable contribution
- This works best when donating long term crypto assets. Crypto held for less than one year does not get the same treatment for charity. If you hold the crypto for less than one year, the charitable contribution deduction will be limited to the lesser of the tax basis or fair market value. This means you do not get to gift the appreciation of your crypto, only what you paid for it, or less if the crypto has gone down in value since you obtained it.
- There are certain percentage limitations for charitable contributions. Generally, your deduction will be limited to 20% or 30% of your adjusted gross income, depending on the type of charity that receives the donation. This to say, I would consult with a tax professional before going ahead and actually donating to make sure you will be entitled to the deduction based off your financial situation.
Lastly I believe donating in crypto adds to the overall adoption of cryptocurrency. As more nonprofits use your crypto donations to make the world a better place, they also bring crypto to their traditional audiences.
What an amazing time to be alive y’all.
Cryptocurrency Tax-Loss Harvesting - What is it?
Tax-loss harvesting is another investment strategy that maximizes after-tax returns by taking advantage of dips in the crypto market. Furthermore, crypto tax-loss harvesting is the selling of crypto assets that are in loss positions to offset capital gains. Wise investors can take advantage of the pricing dips throughout the year in order to capture taxable losses at the lowest points during the year. Most start out by doing this at the end of the tax year, but it is important to note you can harvest losses throughout the entire year.
What makes it unique in crypto is taking advantage of the no wash-sale rule. Wash sale rules prevent a taxpayer from selling a security at a loss and buying back the same asset within 30 days. AT THE MOMENT, these wash sale rules do not apply to crypto. The IRS specifically states wash sale rules only apply to securities. Cryptocurrencies are property, not securities, as defined by IRS guidance. When the market dips, you can sell your assets at a loss and buy them back to offset other capital gains. I expect the IRS to address the no wash sale rule as it relates to crypto at some point, but for now, I am taking advantage of the rules and regulations as they stand.
If you have capital losses left over after netting them against your capital gains for the year, you can deduct up to $3000 of them from your ordinary income. Any additional losses beyond that are carried over to future tax years to offset capital gains. Losses on your investments are first used to offset capital gains of the same type. Short term losses are first deducted against short term gains, and long term losses are deducted against long term gains. Net losses of either type can be deducted against the other kind of gain. Again, any excess net capital loss can be carried over to subsequent years to be deducted against capital gains and against up to $3000 of other kinds of income.
Let’s take a look at an example:
Sam purchased .25 BTC for $10,000 in June, year 1. Sam has no gains or losses yet because he has not recognized a taxable event. Today, Sam still continues to hold .25 BTC.
Rachel also purchased .25 BTC for $10,000 in June, year 1, just like Sam. However, Rachel decided to sell her .25 BTC for $9,000 4 months later in October, year 1. Rachel then uses the $9000 proceeds that she received from the sale of her .25 BTC to repurchase .25 BTC. Rachel can now claim a $1,000 loss on her taxes and just like Sam, she still holds .25 BTC.
What are the risks of tax loss harvesting?
- If you are sitting on long term capital losses, I would caution tax loss harvesting as you will now have to restart the timeline for long term treatment when you repurchase.
- As mentioned earlier, the IRS’s wash sale rule states that a taxpayer cannot claim a loss on a sale or trade of a security if they buy back the security within 30 days. For now, crypto is considered property and not a security, but there are talks of a pending tax bill that would apply the wash sale limitation to crypto trades occurring after December 31, 2021. I plan to keep the group updated on this.
If you are looking to harvest losses over a large number of transactions that have significant complexity (i.e. if you have unrealized losses and gains for a single crypto or if you have bought into the crypto being harvested at multiple price points) I would recommend looking into a service like TokenTax or ZenLedger. They have tax loss harvesting tools that can help simply those more complex transactions. Cryptotrader.tax is also a great resource for this.