With the absence of any specific guidelines and half-baked rules for taxing crypto gains, filing taxes is a bit of a challenge. On top of it, complex calculations make the entire filing process strenuous, and that is resulting in tax evasion. Since bitcoin’s launch, only several hundred are reporting gains and paying taxes.
As cryptocurrencies are becoming more mainstream, the Internal Revenue Service (IRS) is becoming more vigilant and alert over crypto investments. Since the cryptocurrencies in the United States are treated as a form of property like gold or real estate, it is subject to short-term and long-term capital gain. And, it has to be measured in dollar terms, which makes it a bit complex in regards to taxation.
This article will help you navigate the different elements of bitcoin tax reporting and make it easier for you to understand its complexities.
Do’s of bitcoin tax reporting
Always select the FIFO approach while calculating gains
To date, the IRS has not specified the type of accounting methods (FIFO, LIFO, Average price) acceptable for calculation of capital gains. It is imperative to choose the right accounting method for avoiding future penalties and interest. FIFO is used for calculating capital gains on stocks and index funds. So, how does it matter for cryptos?
For example, if you purchase 1 BTC on September 1st for $4,000 and again on October 1st, you purchase 1 BTC for $6,000. Then on December 1st, 2019, you sell 1 BTC for $10,000, the capital gains under LIFO will be $4000, FIFO will be $6,000, and on an average price basis, it will be $5,000.
Choosing LIFO will amount to under-reporting of tax liability and may result in future payment of back-taxes.
Report all your accounts and wallets
There are numerous online crypto tax reporting platforms, through which you can calculate your actual tax liability. To rightly calculate your taxable gains, you need to do the following actions:
- Report all your exchange accounts and wallet balances
- Report all your transactions, especially the gifts, donations, and transfers
It helps in determining the fair market value of your crypto trades, especially for the crypto-to-crypto trades. Further, you do not want the IRS to follow you up for hiding your transactions and paying penalties.
Get the right tax forms
Since cryptos are regarded as property, all the capital gains or losses, whether short-term or long-term, should be reported in Form 8949.
Form 1040, commonly referred to as Schedule D is a summary of your capital gains and losses in a calendar year.
Form 1099-K is required when the gross value of your trades is more than $20,000 or if you have done more than 200 transactions in a calendar year with any US exchange. You will receive this from the exchange that includes all your transactions during the calendar year. It is not shown on a cost basis but needs to be reported to IRS individually.
Crypto donations of over $500 in value should be reported separately on Form 8283.
Don’ts of bitcoin tax reporting
Good record-keeping is crucial for supporting your previous tax payments in case of any dispute. It also helps to calculate capital gains/losses accurately.
It is recommended to keep transaction records for at least three years. Using an online crypto tax reporting platform, it not only helps to calculate your tax liability but also helps in record keeping.
Reporting only losses
You should refrain from reporting only losses or tax-friendly transactions that reduce your tax liability. This is not advisable because the IRS might flag the bitcoin tax report, and penalize you for bitcoin tax evasion. You may end up paying more as penalties than your actual tax liability.
Not considering crypto-to-crypto trades
Many had the impression that taxes on crypto transactions arise when it is converted into fiat currencies, But, it is a myth.
IRS requires you to report every single crypto transaction on dollar terms that create a tax obligation. For example, you purchased bitcoin worth $4,000 and traded it for Stellar worth $5,500. The $1,500 is the profit and capital gain; you should report it while filing the tax report.
Filing your bitcoin tax report
Following is the typical process for filing your bitcoin tax report correctly:
Get your transactions data from your exchange accounts and wallet
- Download the full CSV file of transactions from all your crypto exchange accounts and wallets. Include transactions of the previous year to calculate gains or losses on cost-basis.
- Match transactions between all your exchange accounts and wallets to eliminate false capital gains and losses
Select the right calculation method
- Assign market rates for all your crypto-to-crypto trades to measure it in dollar terms
- Calculate your capital gains/losses using FIFO accounting method
You can use online crypto tax reporting platforms for calculating your tax liability on crypto trades and investments accurately.
File your capital gains using the right tax forms
- Use Form 8949, Sales and Other Dispositions of Capital Assets for filing your capital gains and then, Form 1040, Schedule D for summarized capital gains and losses
- If you want to report ordinary income from cryptocurrencies, use Form 1040, Form 1040-SS, Form 1040-NR, or Form 1040, Schedule 1.
Report your holdings according to FBAR and FATCA
According to FBAR disclosure rules, an individual must file it to the IRS, if he/she has foreign financial accounts that exceed $10,000 in combined value in a financial year. However, you do not need to file FBAR for your crypto holdings.
With respect to FATCA (Foreign Account Tax Compliance Act), it requires every US-based crypto investor who owns assets worth over $50,000 on the last tax-day of the year, $75,000 at any point during the tax year to file FATCA on Form 8939.
And, if you are not sure whether you’ve correctly filed your previous tax reports or want to amend, then by submitting Form 1040X, you can change your previous tax reports.
Comply with deadlines
All tax reports, including cryptocurrencies, need to be filed on or before April 15th every year. If you want to extend your filing date, submit Form 4868 for an extension.
Using online crypto tax reporting platforms, you calculate your crypto tax liability within seconds and also comply with all IRS rules and regulations.