Memorial Day weekend can sometimes feel a little … jarring.
Burgers, pools, picnics — set against the solemn backdrop of remembrance for the sacrifice of so many thousands who have laid down their lives so we can have our freedoms.
However, if you get the chance to talk to veterans (as I sometimes do in the tax preparation world), they’ll often tell you that these very freedoms (the ones much bigger than backyard barbecues, of course) are exactly why those sacrifices are worthwhile.
So, it seems appropriate that the Memorial Day camping excursions and parades are not only the perfect way to kick off the “start of summer,” but also a perfect way to honor the freedoms granted to us through the service of so many men and women.
Now, as my service to those in the my local area, let’s talk about the strange world of cryptocurrency taxation. Unless you’ve been living under a rock, you’re likely already aware of the extreme volatility in the cryptocurrency markets over the past two weeks.
Of course, the crypto markets are always incredibly volatile. Extreme price swings are one of the hallmarks of the entire “asset” class.
These extreme price swings in bitcoin, ether, and all the rest tend to cause people to trade in and out of these assets more frequently than stocks and bonds. However, these trades have tax consequences that we want to make sure taxpayers know about.
So, whether it’s for your own benefit or the benefit of your kids, or even that the Uber driver suddenly gave you some hot crypto tips that you think you’d like to take advantage of, let’s dive into cryptocurrency taxation today.
But first, a quick reminder about the recently expanded Child Tax Credit. The IRS has announced that they will start sending the advance payments on 2021 credits on July 15. The IRS will send direct deposits to taxpayers they have information on file for. The IRS will be opening an online portal by July 1 for you to enter changes in personal circumstances that impact your eligibility or to opt-out of these advance payments.
Now, on with bitcoin…
4 Things Crypto Traders Need to Know About Cryptocurrency Taxation
“Don’t judge each day by the harvest you reap but by the seeds that you plant.” -Robert Louis Stevenson
In recent years, some cryptocurrency traders have been caught off guard by the surprise tax bill generated from their trading activities. Many others have simply failed to report these transactions to the IRS at all, unaware that they even need to. Those folks in particular are in for a rude awakening some day, as the IRS expands it’s enforcement against crypto traders.
So, what are your responsibilities as a trader in terms of cryptocurrency taxation? What if you’re not actively trading these assets, but simply holding them? What records should you be keeping?
Crypto is Taxed as Property
Let’s start with the most important thing you need to understand about crypto, and its relationship with the IRS: The federal government taxes crypto like property.
In other words, the IRS looks at crypto the same way it looks at houses, cars, paintings, even baseball cards. While crypto obviously isn’t a tangible asset the way a painting is, the IRS treats it the same way for tax purposes and that’s something traders will want to keep in mind.
If you buy a painting today for, say, $10,000, and then you sell that painting in December for $30,000, then you’ve made a profit in 2021. You might have some transaction costs, like commissions or listing fees that reduce that profit. Let’s say you pay a 10% commission to an auction house to sell your painting. Sale price was $30,000, so your actual profit is reduced by $3,000, which means you’re sitting at a $17,000 profit.
You’re going to have to pay capital gains tax on this $17,000 profit. Since you held the asset for less than 12 months, your capital gains tax will be the same as your normal income tax rate.
Change the word “painting” in this example to “bitcoin,” “ethereum,” “algorand,” or “dogecoin,” and the example is still perfectly valid. This is how cryptocurrency taxation works in America.
What if you sold some bitcoin last week, and took a loss? Maybe you bought 1 BTC when it was $50,000 a couple months ago. Then, you sold last week when it hit $35,000. So for 2021, you now have a $15,000 loss on bitcoin.
Here’s where things get really interesting. That $15,000 loss can be subtracted from capital gains elsewhere. In other words, the $15,000 loss from bitcoin can be subtracted from the $17,000 gain on the painting. This leaves you only $2,000 in capital gains that you need to pay taxes on.
What if there was no painting? What if your $15,000 bitcoin loss is the only property transaction you have for the year? Unfortunately, you cannot deduct the entire $15,000 loss in 2021. Instead, the IRS limits you to taking a $3,000 per year loss against your other income. The remaining losses are carried over to future years to reduce your income.
So in this example, your $15,000 bitcoin loss becomes a $3,000 tax deduction in 2021, another $3,000 deduction in 2022, etc. until it’s all used up in 2025.
No “Wash Sale” Rule (This is Important!)
One interesting thing about how the IRS treats cryptocurrency has to do with a rule that stock traders have to deal with, but crypto traders don’t.
When trading stocks, if you take a loss on a stock sale, and then buy that same stock again within 30 days, the wash sale rule is triggered. Under this rule, the losses are not deductible when this rule is triggered. This is obviously a thorn in the side of stock day traders.
But crypto traders don’t have to worry about wash sales. As such, crypto traders can actively engage in tax loss harvesting. This means that you sell your bitcoin or other crypto now to lock in that loss for tax reduction purposes. Then, you can immediately turn around and buy back the same crypto in order to reset your basis in that property.
In an asset class as volatile as crypto, this tax loss harvesting capability can be very advantageous to crypto traders over what a stock trader has to contend with.
If you are going to purchase crypto assets and just not trade them, then you don’t have these capital gains or losses to worry about — for now. But if you’re going to “hold with diamond hands” — Internet slang for buy-and-hold crypto investing — then you still need to keep track of your basis. Whenever you make a crypto purchase, keep record of the date of the transaction, the type of crypto, and the amount in US dollars that you bought it for. You will need this information for whenever you do cash out your holdings in the future, even if that isn’t until 10 or 20 years from now.
Note that, under current tax law, you will pay a much lower capital gains tax rate if you hold these assets for more than a year.
Even if you’re day trading crypto assets, be sure to keep the same kind of records. One common mistake that crypto traders make is that they fail to record the value of their transaction in US dollars. It can be quite the hassle to reconstruct these records come tax time, so we highly recommend that you keep track of values in dollars for tax reporting purposes.
New Rule: $10,000 Reporting Limit
If you take more than $10,000 in cash to your bank to deposit it, the bank is required to file a special form with the government to report this $10,000 cash transaction. Most people are aware that this exists.
What many people don’t realize, however, is that this same rule applies to any business transaction involving more than $10,000 in cash. For example, that painting you bought a few paragraphs ago. If that $10,000 had been paid in cash, then the art dealer would need to file the same cash transaction report with the IRS.
This is all part of anti-money laundering efforts for law enforcement.
Well, in an interesting move on May 20, the IRS announced that businesses that receive virtual currency worth more than $10,000 for the purchase of goods or services should file the same type of report as if it were actual cash.
While this is unlikely to immediately impact many people, it’s something traders need to be aware of as more and more businesses start accepting cryptocurrency. While it may still be a fringe issue now, we could be having a very different conversation in one or two years.
Or maybe not — nobody knows.
If you’ve been trading virtual currencies, or even day trading stocks or any other assets, you need to pay special attention to cryptocurrency taxation. Let us help you get your records in order now to make life easier at tax time. Let’s get together soon:
To getting things done,
Emelia Mensa EA, CPA