Fellow Steemers, today I would like to bring you part 3 of my ongoing discussion about cryptocurrencies and your US federal tax reporting obligations. We will be diving in to the mechanics of how to report your transactions. Please see pt. 1 and pt. 2 for more information on what we are talking about.
For today's post, we will be going over how to properly report your gains or losses from transacting in cryptocurrencies over the prior year. In order to be able to follow my below steps, it is important that you always keep good records of your major crypto transactions. If we compare this process to trading stocks, it will quickly become evident that the onus is on us, as individuals, to report transactions. In example, if we buy and sell stocks continuously through a calendar year, our broker is required to report to the IRS the results of these transactions (including cost basis, sale price, etc.). Additionally, the broker will provide you with detailed records of what transactions you entered in to, and frequently we can summarize these transactions to reduce the effort required to report.
In the crypto world, we have no broker looking over our shoulders and keeping tabs on us. Depending on where you buy/sell/transfer your cryptocurrencies, you may have little or no evidence of cost basis, dates, etc. This brings me back to my original theme, that we need to keep good records of what we are doing (or else face the prospect of retracing everything we did back through the blockchain /facepalm).
The discussion below is for reporting purchased & sold cryptocurrencies. It does not cover the receipt of crypto for services, which would likely need to be reported separately as regular income (see my pt. 1 & pt. 2 for more info)
Now, assuming you've kept good records, come tax time you should follow these steps:
The main documentation we will need to prepare is form 8949 & Schedule D
I will begin with a quick description of how to fill out your form 8949. Additionally, the IRS provides (often complex) instructions for the form that can be quickly found through a google search
- The form 8949 is where we provide details of all purchase/receipt of capital assets. There are 2 main sections to the form, the first for our short-term (<1 year) and the second for our long-term (>1 year) gains/losses
- We use this form because all other forms related to property disposition are specific to certain types. Cryptocurrencies do not have clear guidelines, so this form functions as a catch-all for crypto and other assets not covered by another form
- The form is generally a large table, in which each row represents a disposition of a crypto-asset. It is important to note that when we purchase a crypto we do not file anything. Only at disposition do we need to document gains/losses
- Each line should represent a distinct disposition of assets. Generally, if you dispossess assets at different times during a single day or at slightly different prices (during a single day), you can average the transactions (e.g. if you have a sell order that is filled at 3 different price points within an hour or two of each other)
- Figuring out the sale price is generally pretty easy (assuming you are exchanging for USD)
- Figuring out the cost basis is generally a bit more complex
- Although we do not have clear guidance, my interpretation is that we can use FIFO cost basis reporting
- FIFO stands for First In, First Out, and means that whenever we sell a homogenous asset, we assume we sold the first units of the acquired asset first. In example, if I buy 1 BTC on 1/1/17, and 3 BTC on 1/5/17, and then I sell 2 BTC on 2/15/17, I would be selling the 1 BTC from 1/1/17 first, and 1 of the 3 BTC from 1/5/17 next
- In the above example, if the 1/1 purchase was @ $10 and the 1/5 @ $20, my basis for the sale of 2 BTC would be $30. If we sell fractional amounts procured across many different dates/price points, we would use a weighted average formula to calculate cost
- It is important to note that we also identify short term (<1 year held) vs long term (>1 year held) in this schedule. If part of a sale is short term and part is long term, we will want to fill out two separate lines so that we can get the long term tax treatment for the portion held > 1 year
Once we have filled in all rows for all our dispositions, we can feed the results in to our Schedule D
Schedule D is where we bring together all of our short and long term capital gains before feeding in to your 1040
- In Sched D, we can also take advantage of previous losses (Net Loss Carryover)
- It is important to note that even if we lose money on crypto trading, this can actually provide us a tax benefit. I foolishly did not file this form a few years ago because I knew I had lost money trading stocks and didn't want to bother since I knew I didn't owe the government anything... I went back earlier this year and re-filed my taxes for that year and got $490 back!
- Input your long & short term losses in the appropriate fields
- Ensure you have any brokerage statements handy so that you can complete this form for your crypto & other capital transactions at the same time. Without clear IRS guidance, we can take advantage of combining gains/losses on all capital transactions in this one form, and potentially getting benefit out of losses in one area to offset gains in another
In summary, I hope that this discussion helps you understand how best to file your crypto related transactions when tax time comes. Remember, this is only related to filing of disposition of assets. You do not need to file for the purchase of cryptos or other capital assets, as long as they were not received as a form of income.
Please let me know if this advice is useful, and if there are specific situations that you would like me to speak on. I appreciate any and all upvotes and follows
Disclaimer: although I am a registered CPA in the state of California, any thoughts above are merely my understanding of the US tax code and should not be considered tax advise. Further, I am not a Certified Tax Professional or Tax Preparer, and all matters related to filing of your taxes should only be done after consulting with the appropriate professional accountant, lawyer, or other party.
Would love to hear your opinion on how to NOT pay taxes on crypto currency while not breaking any laws.
Buy & hold :)
On another note, will be interesting what we do if they finally become considered currencies. Will there be a one-time tax on the FMV? Can it be deferred? Going forward, will it be taxed like forex trading? IRS HELP US OUT HERE!
I didn't think of that. So, what happens if crypto is treated as currency in 2018? Does that imply if we bought in 2016 or 2017 and sell in 2018, we would not have to pay tax? What if you bought in 2016 or 2017, and then move to a country where crypto is a currency...do you have to pay tax during the move?
Great questions, and either I'm not a good enough CPA to understand or this is a scenario that there is no good guidance on.
Possibly if we look back at what happened when the IRS first codified how currency trading works, we could get an inkling as to how it would work.
All I can tell you, is that the IRS will certainly make sure we give our pound of flesh no matter how it works out!
If you or other CPA cracks that code, they would get a lot of business!
FIFO cost basis reporting seems sensible. An interesting question though is what if you keep your virtual currency in a number of exchanges (for instance, to reduce risk in case of hacking)? Do you apply FIFO across all exchanges/wallets, or within each separately? The former seems the most natural to me since it simplifies your recordkeeping and computation of cost basis; but the question is, what do you think is the most likely interpretation of the law?