Cryptocurrency Tax Reporting: Essential Guidelines

In 2017, cryptocurrencies like Bitcoin, Litecoin, Ripple, Ethereum, Zcash, Dash, Monero, and Dogecoin became popular and profitable. As a result, many investors sought help from accountants, unsure of how to handle cryptocurrency tax reporting for their gains. If you’ve made profits from cryptocurrencies but haven’t reported them, it’s important to act now.

Gains and IRS Reporting

You must report any gains from real estate, precious metals, stocks, or cryptocurrencies to the IRS. Use Schedule D to categorize these gains as either long-term or short-term. For example, if you bought an asset for $1 and sold it for $100, you have a taxable gain of $99. However, if you still hold the asset by December 31 and haven’t sold it, no taxable event occurs unless you’ve chosen mark-to-market accounting.

Link to qualified trader IRS site section

Understanding Holding Periods

To qualify for favorable tax treatment, aim for a holding period of more than one year before selling an asset. Long-term capital gains are taxed up to 20%, significantly lower than short-term gains, which can be taxed as high as 39.6%. Keep in mind that state taxes vary, so check your state’s department of revenue website or consult with us to determine your specific tax rate on long-term capital gains.

Forms and Reporting Requirements

All capital gains transactions go into Schedule D of Form 1040. However, the details should be reported elsewhere—qualified traders might use Form 4797, while most report these gains and losses on Form 8949. A site like bitcoin.tax can help categorize these transactions, but be prepared for challenges if you have a large amount of transaction data.

Common Challenges in Crypto Reporting

• Handling Extensive Data: Active cryptocurrency investors often face difficulties summarizing large amounts of data for Form 8949 or Schedule D. Data analysis skills may be required.
• Converting to USD: Transactions not listed in USD can complicate the process.
• Calculating Holding Periods: Determining the holding period can be tricky, especially with multiple purchases. The IRS recommends specific identification or FIFO (first in, first out), with FIFO generally extending the holding period.
• Mixing Purchases and Sales: Only report sales, sale prices, original costs, dates of sale, and purchase dates for the year. Exclude any items bought but not sold from the annual data.

Handling Capital Losses

After completing your 8949 and Schedule D, they will roll into the front page of Form 1040 of your individual tax return. If you show gains, you’ll be taxed on them. If you show losses, you can only deduct capital losses up to the amount of capital gains. The IRS allows a minimal deduction against ordinary earned income if your losses exceed your gains, capped at $3,000. However, unused losses can be carried forward to future years indefinitely.

For instance, if you lost $100,000 in 2016 and had no gains to apply the loss to, you could deduct only $3,000 toward your 2016 earned income. The remaining $97,000 would carry forward to 2017. If you made $200,000 in gains in 2017, you would only pay taxes on $103,000, as the $97,000 from 2016 would apply, reducing your tax burden.

Link to states with no income taxes, etc.

Importance of Accurate Record-Keeping

Accurate tracking of prior year losses is essential. Many clients forget to include their Schedule D investment losses from prior years, leading to unnecessarily high tax bills when they sell a portion of their business or make a significant profit. If your tax return is complex or time-consuming, consult a qualified professional. It could save you significant money in the long run.

Final Thoughts

Cryptocurrency tax reporting can be complex. Managing extensive transaction data, calculating holding periods accurately, and handling capital gains and losses require professional guidance.

If you have any questions about cryptocurrency tax reporting or need assistance with your tax preparation, please don’t hesitate to contact us.