How to Calculate Cryptocurrency Taxes for IRS Reporting
Cryptocurrency investing has exploded in popularity in recent years. However, many crypto investors are unaware of the tax implications of buying, selling, and trading digital currencies like Bitcoin and Ethereum. Failure to properly calculate and report cryptocurrency taxes can result in penalties, interest, and audits by the IRS. This comprehensive guide breaks down everything you need to know about cryptocurrency taxes.
Overview of Cryptocurrency Taxation
In the United States and many other countries, cryptocurrency is treated as property for tax purposes. This means that capital gains and losses from your crypto transactions must be calculated and reported on your tax return. Just like stocks and bonds, you incur capital gains taxes when you sell crypto for a profit.
Anytime you sell, trade, or otherwise dispose of your cryptocurrency, it is considered a taxable event. This includes:
- Selling crypto for fiat currency like USD
- Trading one crypto for another (i.e. Bitcoin for Ethereum)
- Using crypto to purchase goods and services
- Receiving crypto as income (mining, staking rewards, airdrops, etc.)
Calculating Cryptocurrency Capital Gains/Losses
In order to calculate your crypto capital gains and losses, you first need to determine your cost basis for each digital currency.
Your cost basis is how much you paid to acquire the cryptocurrency, including fees and commissions. For cryptocurrency you purchased, your cost basis is the total purchase price in USD.
For cryptocurrency received as a gift, through an airdrop, or by mining it yourself, your cost basis is $0. The full value when you dispose of it is taxable.
Capital Gains & Losses
Once you know your cost basis, you can calculate capital gains or losses for each taxable crypto transaction:
Capital Gains - If you sell crypto for more than your purchase price, you have a capital gain. This must be reported to the IRS and is subject to capital gains taxation.
Capital Losses - If you sell your cryptocurrency for less than you paid for it, you have a capital loss, which can be deducted on your tax return to offset capital gains and reduce your tax liability.
The formula to calculate capital gains or losses is:
Capital Gain/Loss = Sale Price - Cost Basis
Be sure to also factor in any fees paid when buying or selling crypto when determining cost basis and sale price.
FIFO vs LIFO Accounting Methods
When calculating cryptocurrency capital gains and losses, you must use either the FIFO (First In, First Out) or LIFO (Last In, First Out) accounting method.
FIFO - With FIFO, the first crypto assets you purchased are considered the first sold. This maximizes capital gains.
LIFO - With LIFO, the most recently acquired crypto assets are considered sold first. This minimizes capital gains.
You must stick with one method consistently across all crypto transactions for the tax year. Carefully consider which accounting method makes the most sense for your specific crypto transactions.
How to Report Crypto Taxes on Tax Returns
Any capital gains or losses from cryptocurrency transactions must be reported on IRS Form 8949. The totals carry over to Schedule D and ultimately your 1040.
You must file Form 8949 and Schedule D even if you had no crypto gains/losses but made crypto transactions. Failing to report can lead to stiff penalties.
For recipient addresses, list the exchange where you bought or sold the crypto (i.e. Coinbase, Kraken, etc.).
Tax Saving Strategies for Crypto Investors
Proper tax planning can help cryptocurrency investors maximize returns. Some strategies include:
Tax-Loss Harvesting - Strategically selling crypto at a loss to offset capital gains tax.
Long-term Holding - Holding crypto for over a year qualifies you for preferential long-term capital gains tax rates.
Donating Crypto - Donating appreciated cryptocurrency can qualify you for a tax deduction without having to pay capital gains.
Cryptocurrency Tax Software
Using cryptocurrency tax software can simplify calculating gains, imports transactions, generates tax reports, and files your crypto taxes. Leading software options include:
Take the time to properly calculate and report your crypto taxes this tax season. With the right preparation, you can avoid penalties and make the most of your crypto tax situation. Consult a tax professional if you need assistance.