The rise of cryptocurrencies as investment vehicles has raised a number of issues, including how consumers should address this new investment category on their taxes.
Tax advisers say that even though the IRS outlined guidelines about cryptocurrencies clearly, many consumers are making time-consuming and costly mistakes, particularly as trading mushrooms. These advisers counsel consumers to follow sound practices, including keeping detailed records of the size and timing of cryptocurrency investments.
Their advice comes as taxpayers are less than a month away from the 2017 filing deadline. In 2017, bitcoin’s (BTC) price surged more than 1,300 percent. Ether’s (ETH) price skyrocketed more than 11,000 percent. Other cryptocurrencies registered sizable gains as well, which could lead to large capital gains taxes for individuals who bought low and sold high.
Below are common mistakes and ways to avoid them.
Common Crypto Tax Mistakes
According to its 2014 cryptocurrency guidelines, the IRS considers the virtual currency property and any profits from its sale as capital gains. Under capital gains rules, short-term investments an investor holds for one year or less are taxed at the same rate as wages, while long-term investments an investor holds for more than one year are taxed at a rate anywhere from zero to 20 percent.
“The IRS treats virtual currencies as property, rather than regular cash income,” Tricia Drago, a tax representative with HappyTax.com, told ThirtyK. “As a result, crypto taxes are based on the capital gains rules. Capital gains depend on several factors like how long you held a coin before trading it, and what cost basis calculation you opted to use to establish your gain or loss.”
Yet Drago said that some investors are “not properly applying the capital gains tax rules to their cryptocurrency tax calculations.”
William Perez, a senior tax accountant with Visor, told ThirtyK the most common mistake his firm has encountered is when investors forget to report cryptocurrency transaction profits on their tax returns, partly due to how their brokers or exchanges handle the transaction.
“Most cryptocurrency brokers do not send out 1099 forms or some other tax document to their customers,” Perez said. “As a result, it’s easy to overlook this when pulling together all your documents for tax time.”
Tom Koceja, a senior tax accountant with Anton Collins Mitchell, told ThirtyK that the challenge with accurately reporting cryptocurrency stems from reporting gaps from the exchanges and how each exchange handles the basis and transaction fees and the transfer of the currency from one exchange to another.
Some taxpayers also mistakenly assume they need to report cryptocurrency sales only if they involve a conversion into traditional cash, such as through Coinbase, Andrew Perlin, co-founder of Crypto CPAs told ThirtyK.
“Many investors and traders traded coins under the assumption that it was all tax free until cashed out into fiat,” Perlin says. “Unfortunately, trading from one coin to another is typically a taxable event with few exceptions.”
Some U.S. investors have also assumed that any cryptocurrency transactions conducted overseas on a foreign cryptocurrency exchange must not be reported to the IRS. However, Drago noted trading of cryptocurrency on a foreign exchange, or through a foreign company, is also subject to additional legal and financial requirements.
Strategic planning on timing the sale of cryptocurrencies can make a noteworthy difference come tax time, experts say.
“Most know that long-term capital gains are taxed at a lower rate than those of short term, but many do not know that you may deduct either type of loss from either type of gain in the calendar year in which they are realized,” Perlin says. “If you have more capital losses than you do capital gains, whether from cryptocurrency transactions or any other capital transaction, you may deduct up to a $3,000 loss. The remaining loss may be carried forward to future tax years.”
He added that if a cryptocurrency investor did not make much income, he or she would benefit from selling the coins that would yield the most profit. But he said that if an investor is likely to earn sizable profits, the investor should consider delaying the sale potentially profitable coins because it would only increase the taxes owed.
Perez stressed the need for cryptocurrency investors to be diligent in their record keeping:
”Keep track of the amount of money you invest, how many coins you buy, and how much you sold the coins for,” he says. “Some brokers will provide you with data so you can track this. But at the present time, it’s technically not the broker’s responsibility to track this information. That means it is the person’s responsibility to keep good records of their cryptocurrency investments. That way they can prepare a complete and accurate tax return without fear of making a mistake.”