Cryptocurrency capital gains taxes are becoming a point of interest for governments. In 2017, which will likely come to be known as the year crypto went mainstream, the combined market cap for all cryptocurrencies rocketed up from 15 billion to over 600 billion dollars. This kind of growth isn’t hard for just the day-traders and blockchain evangelists to ignore, but for governments as well.
Don Fort, the Chief of the IRS criminal investigation unit, recently spoke on a tax conference panel and discussed at length how “cryptocurrency is becoming a new area of enforcement for him.” Other events like the IRS Coinbase Summons and the IRS warning sent to tax filers show the clear intentions of the US government.
Because cryptocurrency is treated as property (not as currency), it is subject to capital gains taxes–just like stocks, bonds, real-estate, and other forms of personal property. Boiled down, you incur capital gains whenever you sell property for more than you purchased it for. You then report this gain on your yearly taxes and pay the requisite capital gains tax as part of your annual income tax reporting. That’s the end of it. The same is true for cryptocurrency.
While the intentions of the government are clear–they want you to report your crypto gains–active crypto-traders know that the sheer volume that comes with trading crypto brings about a slew of challenges and headaches for the tax reporting purposes. Before diving into these challenges, let’s break down capital gains for income tax purposes.
So how do I calculate my cryptocurrency capital gains?
Step 1 – Determine your cost basis
Cost basis is the original value of an asset, or essentially how much money you put in to acquire that asset. For crypto assets, the cost basis includes the purchase price plus all other costs associated with purchasing the cryptocurrency. Other costs typically include things like transaction fees and brokerage commissions from the exchanges you purchase crypto from. So to calculate your cost basis you would carry out the following:
(Purchase Price of Crypto + Other fees) / Quantity of Holding = Cost Basis
For example, if you invested $500 in Litecoin back in November of 2017, that would have bought you about 5.1 Litecoin. Let’s say you also paid Coinbase a 1.49% transaction fee on the purchase. Your cost basis would be calculated as such:
($500.00 + 1.49%*500)/5.1 = $99.50 per Litecoin
Step 2 – Determine the Fair Market Value at the time of the trade
The Fair Market Value is the second data point you need to calculate your capital gains. Fair Market Value is the value of your cryptocurrency at the time you sold/ traded it. Let’s say you sold two of your Litecoin five months later for $300. To calculate your gain you would do the following:
$300 – (99.50 * 2) = $101.00
Your cryptocurrency capital gains on the transaction would be $101.00, and you would owe a tax on that gain.
Keep in mind that coin-to-coin trades are also taxable events. Let’s look at one more simple example to show how you would calculate your capital gain on a coin-to-coin trade.
Let’s say you purchase $100 worth of Bitcoin including transaction and brokerage fees. That $100 currently buys about 0.01 Bitcoin. Now let’s say two months later you trade all of your 0.1 Bitcoin for 0.16 Ether. How would you calculate your capital gains for this coin-to-coin trade? Well, turns out, it depends on what the Fair Market Value of Bitcoin was at the time of the trade. Let’s say at the time of the trade, 0.01 Bitcoin was worth $160. This would make the Fair Market Value of 0.01 Bitcoin $160. You would then be able to calculate your capital gains based of this information:
160 – 100 = $60.00 capital gain
For that crypto-to-crypto trade, you would owe the government a percentage of your $60.00 gain.
IRS: “See that’s easy enough isn’t it?”
Crypto day-trader: “No”
It’s no secret that some people are trading crypto a lot. We’re talking about thousands and thousands of trades every single month. This sheer volume makes it nearly impossible to do this type of calculation on every single trade. Enter crypto tax software to solve this problem. My company CryptoTrader.Tax, along with Get Crypto Tax, CoinTracking, and a number of others are all working to solve this problem by offering simple crypto tax calculation solutions. I implore you to check them all out before deciding which one to use.
What if I don’t pay my cryptocurrency capital gains taxes?
The notion that one does not have to pay taxes on cryptocurrency trading gains due to the anonymity that comes with blockchain is a risky one. The blockchain is a distributed public ledger. Anyone can view the ledger at any time. Figuring out an individual’s activities on that ledger comes down to associating a wallet address with a name.
I interviewed Brett Cotler, a tax attorney with Seward & Kissel LLP who specializes in cryptocurrency and ICO’s, and asked him this very question. Brett said that “I would never advise my clients to take this stance.” He went on to say that the IRS can obtain the data they need. “Whether it’s through John Doe summons to Coinbase or going through the Bitcoin Ledger, they will get that data one way or another.”
So, unless you want to get the dreaded IRS audit notice, then you should make sure that your trades are tracked and consider using software to work out your capital gains tax as you go. A simple spreadsheet with trades and values looks far more convincing than a guesstimate at the last second and no figures to back it up.
Cryptocurrency exchanges are getting busier and that means the Internal Revenue will want their piece of the action. Virtual currency gives a lot more options for making money online, but the IRS will have to find a way to monitor and administer fair charges. The cryptocurrency exchanges themselves could even build in full capital gains tax reporting as a bolt-on service for traders with high daily trading volumes.
What about the actual reporting process?
In terms of how to report cryptocurrency on taxes, you will need two specific forms. First, you will need to fill out the IRS form 8949 which will detail each crypto trade that you made during the calendar year, as well as the date sold, date acquired, cost basis, and capital gain. You will then need to total up all of these items to arrive at your total gains and report that number on your 1040 Schedule D.
While April may have already come and gone, it is important to stay up-to-date if you are an active cryptocurrency trader or investor to be sure you are prepared for the next tax season. In the meantime, I plan to continue actively trading and networking within the broader blockchain community.
These are exciting times that we live in; opportunity is right around the corner.