Disclaimer: This post is provided for informational purposes only. It is not intended to substitute for tax, investment, financial, nor legal advice. For financial, tax, or legal advice please consult your own professional.
The IRS has a complicated tax code in the United States. Understandably, it can be easy to ignore the black box of taxes, however understanding these rules can help you minimize the amount you pay in taxes and save you a huge amount of money.
Capital Losses from Crypto Trading
Since the IRS has issued guidance that cryptocurrency is property, when you dispose of a crypto asset (e.g. sell, trade, use for a purchase, etc.), it triggers a capital event. If the proceeds from the disposal are lower than the cost basis of the asset, then you have a capital loss.
For example, you can claim capital losses1 to offset your capital gains (even in a different asset class) to reduce the amount of capital gains taxes you owe. You can also roll over losses to future years without expiration if you do not have sufficient capital gains to offset in the given year. This is why it is incredibly valuable to file your cryptocurrency taxes, even when you have losses in a particular year.
Guidelines for Filing
In the US, the IRS has not specified guidance for how exactly to calculate capital gains on cryptocurrency transactions. To be consistent with IRS guidance for other assets, such as stocks, bonds, and mutual funds, you should apply either the first-in, first-out (FIFO) method or the specific identification method.
Under FIFO, the first coin that you purchase (chronologically) is the first coin counted for a sale. Under specific identification, you select which specific coin is being sold in a transaction. This can be ad-hoc or according to a pattern (e.g., highest-in-first-out [HIFO], last-in-first-out [LIFO], etc.).
FIFO is the most straightforward and conservative method to calculate capital gains, and is what most tax professionals would recommend you apply. Applying the specific identification method adds complexity and requires alerting your broker/exchange which specific coins you are trading at the time of transaction, as well as receiving written confirmation from the broker/exchange that those were the coins transacted.
Capital Gains Rates
Capital gains may be taxed at two different rates depending on the length of time that the assets have been held. If you have held coins for one year or less, any gains are considered short-term capital gains. In this scenario, the gains are simply added to your income for tax purposes and taxed at your ordinary income tax rate (2018 rates, 2019 rates). This is the higher tax treatment scenario.
If you have held the coins for more than one year, any gains are considered long-term capital gains. In this scenario, the gains are taxed between 0 – 20% depending on your ordinary income tax rate (you can determine yours here). This is the lower tax treatment scenario.
Margin Loans Using Your Cryptocurrency
Services like BlockFi allow you to collateralize your cryptocurrency (e.g. Bitcoin, Ether, or Litecoin) in exchange for a USD loan. Unlike selling, trading, or disposing your cryptocurrency, collateralizing crypto for a fiat loan is not a taxable event. This means that you can utilize a margin loan like this if you do not want to liquidate your cryptocurrency but still want liquidity for other expenses, such as funding a business.
Crypto Tax Filing Software
Calculating cryptocurrency taxes can get confusing. Proper record keeping involves trade-by-trade records that include everything from timestamp to USD cost basis of the digital assets you’re trading. Services like CoinTracker can help you calculate your capital gains and prepare your crypto taxes. CoinTracker securely syncs your transaction history from popular exchanges & wallets across 2,500 different cryptocurrencies to provide your completed IRS Form 8949 (or capital gains report for Australia, Canada, or the United Kingdom).
Thanks you to Clinton Donnelly, Enrolled Agent (Donnelly Tax Law), Shehan Chandrasekera, CPA (JAG CPAs) for consulting on this post.