Cryptocurrencies like Bitcoin have become considerably more popular over the past few years. Due to its rise, governments have started paying close attention to the new form of currency.
In 2019, The Internal Revenue Service (IRS) released new crypto tax guidelines and issued thousands of warning letters to tax defaulters. These guidelines specifically list if a person is eligible to pay taxes on their cryptocurrency.
First and foremost, the IRS has stated that for tax purposes, Bitcoin and other cryptocurrencies should be treated as property (stocks, gold, real estate, etc.). This means that capital gains and losses are to be reported on all your crypto trades. Failing to do so will make you liable for tax fraud.
How to Calculate Crypto Capital Gains or Losses?
This is relatively straightforward, before getting started you need to understand which crypto events are taxable. A taxable event is defined as, “a specific action that triggers a tax reporting liability.” Whenever this event occurs a capital gain or capital loss is incurred.
Events which are taxable
When trading cryptocurrency to fiat currency (USD).
When trading cryptocurrency to cryptocurrency.
When using cryptocurrency to pay for goods and services.
When earning cryptocurrency as an income (In mining or other forms).
Events which are not taxable
When cryptocurrency is received as a gift.
When transferring cryptocurrency between different exchanges or wallets (as long as there is no capital gain or loss).
When purchasing cryptocurrency in USD (gains are not realized until you trade or sell them).
How to Determine Your Cost Basis?
The cost basis is the money you put into purchasing your property (cryptocurrency). It includes the purchase price plus all other costs (transaction fee, brokerage commission) associated with purchasing the cryptocurrency.
(Purchase Price of Cryptocurrency + Other fees) / Quantity of Holding = Cost Basis
Next, subtract your cost basis from the selling price of your cryptocurrency. The selling price is also referred to as the Fair Market Value.
(Fair Market Value – Cost Basis = Capital Gain or Loss)
In case money is lost when trading cryptocurrency, you can file the loss amount and avail a deduction up to $3000.
This calculation of Fair Market Value is highly problematic for crypto traders as some traders have been dealing in cryptocurrency for months and have not kept track of the dollar value (Fair Market Value) at the time of trading their crypto assets. The Fair Market Value is required for traders to accurately file their taxes. Now, many of them are turning to the aid of crypto tax softwares to automate their entire tax reporting process.
Short-Term Capital Gains vs. Long-Term Capital Gains
A short term capital gain occurs when you hold a cryptocurrency for less than a year and sell the cryptocurrency at more than your cost basis. These short term capital gains taxes are calculated at a marginal tax rate.
A long term capital gain occurs when you have held your cryptocurrency for a year or more. This is the long term rate is much lower and investors are rewarded if they hold their cryptocurrency continuously, for a year or more.
However, if you mine cryptocurrency there are two separate taxable events. The first will be as income from the dollar value of the coins you have mined and the second is the capital gains or loss you have incurred when trading your mined coins. Depending on whether you mined cryptocurrency as a hobby or as a business entity, the income will be reported differently.
To report crypto transactions you are required to submit 2 forms, Form 8949 and Schedule D.
In Form 8949, all cryptocurrency trades have to be listed along with the date on which you acquired the coins, the date sold or traded, your cost basis, your gain or loss and your proceeds (Fair Market Value).
Once all the crypto trades are listed, sum up the total at the bottom and transfer the total amount to the Schedule D form. Both of these forms should be included with your yearly tax returns.
The Best Crypto Tax Softwares
Once all transactions related to your crypto data is in one place, the process of reporting each transaction can begin for tax purposes. This is where crypto tax softwares comes in handy.
This software is designed and built for crypto traders to solve their tax reporting issues. It allows crypto investors to import all of their trading data by integrating their crypto exchanges and making it easy to collect everything into one platform. Once all crypto data is acquired, CryptoTax can auto-generate all necessary tax reports such as Form 8949. The completed reports can be downloaded or sent to your Certified Public Accountant (CPA) for further use.
If you’re looking for an excessively simple way to calculate your cryptocurrency taxes, ZenLedger should fit the bill. With integration for all leading crypto exchanges, ZenLedger can import your entire crypto history. Then, automatically fill in the information for your tax documents. Documents that can be generated are income reports, closing reports, donation reports and capital gain reports. If needed, a profit and loss statement for you or your CPA can also be generated.
ZenLedger has 3 distinct pricing options based on your requirements. Any document created through ZenLedger is IRS-friendly which means you can use them along with your other tax return reports without any complications.
Choosing to not report your cryptocurrency transactions could make you liable for tax fraud. The IRS can enforce a number of penalties like criminal prosecution or up to a jail term of 5 years as well as a fine of up to $250000.
Raj Kumar is a qualified business/finance writer expert in investment, debt, credit cards, Passive income, financial updates. He advises in his blog finance clap.