The government found that fewer than 900 taxpayers reported bitcoin gains on their tax returns between 2012 and 2015 despite more than 14,000 Coinbase users recording transactions of $20,000 or more during the time period—that’s a lot of crypto taxes avoided, without factoring in other exchanges!
The government sued Coinbase in 2017 and forced the exchange to turn over the names, addresses, and tax IDs for nearly 15,000 of its six million customers. The simple message is this: If you made money with cryptocurrencies, the IRS wants its share of taxes, or else you will be subject to penalties.
In this article, we will take a look at how you can stay on the right side of the law by properly filing your crypto taxes, although it’s important to note that this article is not individual tax advice and everyone should consult a CPA to understand their unique situation!The government’s message is simple: If you made money with cryptocurrencies, the IRS wants its share of taxes. Click To Tweet
How the IRS Treats Crypto
The IRS issued its original guidance on cryptocurrencies in 2014. According to Notice 2014-21, cryptocurrencies are treated as property, rather than a currency, for tax purposes. This means that you must pay taxes on cryptocurrencies in the same way that you’d pay taxes on a stock investment.
The process works like this:
- You purchase a cryptocurrency for US$10,000 (or another cryptocurrency that’s worth US$10,000 at the time of the transaction). This is your cost basis.
- The cryptocurrency rises in value to US$20,000 and you sell it for U.S. dollars (or another cryptocurrency worth US$20,000 at the time of the transaction). This is the sale total.
- You owe income tax on the US$10,000 gain in value, which is calculated by subtracting the cost basis from the sale total. The actual tax depends on other factors like your income.
For more information on these IRS rules, you can read IRS Notice 2014-21, which contains questions and answers covering a wide variety of edge cases.
Tracking Your Crypto Transactions
The first step in the process is documenting your cryptocurrency transactions. If you can’t prove your cost basis, you will owe taxes on the entire gross proceeds.
For example, suppose that you bought a cryptocurrency for $10.00 and sold it for $20.00. You should only owe taxes on the $10.00 gain, but if you don’t have proof that you bought it for $10.00, then you will owe tax on the $20.00 in total proceeds.
The good news is that most crypto exchanges automatically track your transactions for tax purposes. The bad news is that traders using multiple exchanges will have to consolidate the information in a single place. It’s also a good idea to regularly download and store these reports to avoid issues.
ZenLedger automatically imports cryptocurrency transactions from all major exchanges (and a growing number of niche exchanges). That way, you can rest assured that all of your transactions are being properly recorded without having to manually login and download regular reports.
Calculating Crypto Gains and Losses
The second step is calculating your gains and losses ahead of tax preparation. While this process can be straightforward if you only traded for U.S. dollars, many experienced traders participate in initial coin offerings (ICOs) or use cryptocurrencies to buy other cryptocurrencies.
These transactions can make it difficult to track down the cost basis and calculate gains and losses in U.S. dollars—especially for traders making hundreds of transactions each month.
Let’s take a look at how to calculate the gain or loss in a complex situation:
Suppose that you purchase US$100 worth of bitcoin and hold onto it for a few days. You then use the bitcoin to purchase ether and hold the ether for a few more days. After a couple more days, you sell the ether for U.S. dollars.
This transaction would involve several capital gains or losses:
- The bitcoin’s cost basis was US$100 and the selling price was the value of the ether received in U.S. dollars.
- The ether’s cost basis was the value of the bitcoin when it was used to purchase the ether and the selling price was the amount of U.S. dollars received when selling the ether.
ZenLedger helps avoid these confusing transactions by automatically calculating capital gains and losses from each transaction—even across multiple exchanges.
IRS Form 8949 and Schedule D
The third and final step is adding these gains and losses to your tax return. In many cases, you can reduce your accounting costs by providing the information needed for these forms in advance. Accounting can become costly when accountants need to manually compile the information charging an hourly rate.
IRS Form 8949 is required to document the sale and other disposition of capital assets. For each transaction, you must report several pieces of information:
- Description of property
- Date acquired
- Date sold or disposed of
- Proceeds from the sale
- Cost or other basis
- Adjustments to gain or loss
- Total gain or loss
IRS Form 1040 Schedule D is where you take the information from Form 8949 or the Form 1099-Bs provided by your exchange and calculate your total gain or loss. The calculations on this tax form are carried over to Form 1040 and used to compute your total tax burden owed to the IRS.
Tools to Simplify Crypto Taxes
Cryptocurrency taxes aren’t rocket science, but it can be a tedious process. If you make mistakes, you could incur IRS penalties and interest.
The good news is that there are many ways to simplify the process. For example, it’s a good idea to stick to the major exchanges to avoid any issues. Many of them enable you to export transactions and they have Form 1099-Bs that are filed automatically when you surpass a certain dollar value limit.
ZenLedger Crypto Tax Preparation – Source: ZenLedger
ZenLedger takes things a step further by consolidating transactions across multiple exchanges, calculating gains and income and auto-filling IRS forms like Form 8949 and Schedule D. You can take this information to your accountant to reduce the cost of filing taxes or use the TurboTax integration to file your own taxes with far less effort.
ZenLedger also handles edge cases like cryptocurrency mining, ICOs and AirDrops, donations and LIFO/FIFO designations, as well as provides advanced features like tax loss harvesting.
The Bottom Line
Cryptocurrency taxes may seem intimidating, but the process is relatively straightforward. The problem is that computing gains and losses across multiple platforms and cryptocurrencies can be time-consuming and error-prone. There are also many edge cases that can potentially cause issues.
ZenLedger makes it easy to import cryptocurrency transactions, calculate gains and income and auto-fill IRS forms.
Sign up today to try the platform for free!