The crypto tax season is getting closer. With so many investors entering the crypto market over the past year, it means they will have to grapple with a new asset class for their taxes. And even for seasoned investors, the regulatory landscape is constantly changing. Here’s what you need to know about filing crypto taxes for 2020.
The US Internal Revenue Service (IRS) ruled in 2014 that Bitcoin and other cryptocurrencies should be treated as “property,” meaning they qualify for capital gains treatment similar to traditional assets like stocks and bonds. However, there are some cases where certain digital asset activities are treated as income and are therefore subject to income tax.
Which crypto actions are taxable events in the US?
Capital Gains Tax Events in relation to cryptocurrencies include:
- Selling cryptocurrency for fiat (US dollars, British pounds sterling, Japanese yen, etc.)
- Using the cryptocurrency to buy goods and services.
- Trade or exchange one crypto asset for another, either on an exchange or directly peer-to-peer.
Income tax events include:
- Receiving cryptocurrency from an air drop
- All crypto interest income from DeFi loans (decentralized finance)
- Crypto mining revenue from block rewards and transaction fees
- Crypto from liquidity pools and stakes
- Receiving cryptocurrency as a means of payment for performing work, including bug bounties
It’s worth noting that trading losses can be used to offset your capital gains and deduct up to $ 3,000 from your normal income tax based on how long you’ve held the assets (see below). Any additional losses can be carried forward to the next tax year. However, you must show a loss on all assets of a given class in order to qualify for capital gains reduction.
Bob owns a selection of crypto assets and company stocks. His company stocks performed well over the year, and Bob posted a profit of $ 10,000 that he paid out and is subject to capital gains tax. However, Bob’s crypto assets performed poorly and he lost $ 14,000. So he decided to cash out.
Since Bob had a net loss on all of his capital assets (crypto and stocks), he can fully offset the capital gains owed on his $ 10,000 gain to zero and use the remaining $ 4,000 to lower his normal income tax by a maximum of $ 3,000 and carry over the remaining $ 1,000 to the following year.
How much tax do you pay?
In the US, the amount of capital gains tax you owe on your crypto activity depends on how long you’ve held your wealth and what income tax bracket you are in.
This is divided into two parts:
- Short term capital gains: Any gain or loss from a crypto asset held for less than a year will be taxed at the same tax rate as the income tax bracket you are in. A full list of tax brackets for 2020-21 can be found here. Losses can be used to offset income tax by a maximum of $ 3,000. Further losses can be carried forward as mentioned above.
- Long-term capital gains: Profits or losses from a crypto asset held for more than a year are subject to a much lower tax of 0%, 15% or 20% depending on individual or combined marital income.
Source: Internal Revenue Service
Losses from swap hacks or theft
The major changes in tax law from December 2017 confused many crypto investors who were exposed to fraud, hacks, or other ways of losing crypto investments.
The amended law limits the loss of personal injury to a “federal disaster”.
Many crypto investors and accountants mistakenly thought this restriction would apply to their crypto investments. However, this is not the case, according to the CryptoTaxAudit legal team.
Crypto investment losses are not “personal injury losses”. Instead, they are classified as investment losses under tax code 165 (c) (ii) as they are “for-profit transactions but not related to any trade or business”.
As a result, all crypto losses in the event of fraud, theft, or accidents are total tax losses. These losses can be claimed on Form 8949 when making $ 0 worth of transactions. This means that if you bought a bitcoin for $ 15,000 and it was stolen by an exchange hack, you can report a loss of $ 15,000.
Ponzi fraud loss deduction
Ponzi fraud losses can be treated as individual deductions and are not subject to the $ 3,000 capital loss limit. The amount invested in the fraud can be deducted from your taxable income. This treatment is also known as the “Bernie Madoff trigger,” named after former Nasdaq stock exchange chairman Bernard Madoff, who was convicted of leading one of the largest financial fraud operations in history. The most important requirement is that someone has been charged for the loss to count as a Ponzi deduction.
How to prepare for the crypto tax season
Now that you know how your crypto assets are taxed, here’s what you need to do to prepare, file, and pay your taxes:
- Keep a record of all of your cryptocurrency activities: The IRS requires all crypto users to accurately record all purchases and sales of cryptocurrencies, including air drops, loan interest, and all other activities listed above under Capital Gains and Income Tax Events. Most of the leading crypto exchanges and platforms have built-in tax reporting capabilities that will automatically generate reports for you. However, there are third-party services that offer to do all of the legwork for you (see below).
- Calculate your winnings and losses: Once you have your full transaction report, there are a number of services or tax calculators you can use to find out what you owe, or you can do it manually depending on how many trades you made in the year. The amount is found by finding the difference between the price you sold at and the cost base (the original price you paid).
- Fill out Form 8949 and add it to Form Schedule D: Form 8949 is the specific tax form for reporting cryptocapital gains and losses. The Schedule D form is the primary tax form for reporting total capital gains and losses. Any cryptocurrency earned as income must be added to Schedule 1 Form 1040, and independent cryptocurrency income must be added to Schedule C.
- Submit forms and pay any taxes owed.
Crypto Tax Services for US Citizens
The following platforms offer a range of crypto tax services and can do the whole process for you:
If you have a particularly complex crypto tax situation, it is advisable to seek help from a professional tax advisor. This article is for informational purposes only and should not be construed as tax or accounting advice. Always seek professional advice from a tax advisor when assessing your individual tax situation.