Understanding Cryptocurrency Taxes

We know it’s been a rough year for everyone in crypto. Volatility was high, and profits were low. Everyone feels a bit beat up. So we wanted to help you out before year’s end with some of the most important cryptocurrency accounting and tax tips to make savvy decisions based on your current portfolio.

The Current Tax Landscape

Beginning in 2017, the IRS started caring about Know Your Customer/Anti-Money Laundering (KYC/AML) regulations in crypto investments. The IRS famously won a lawsuit against Coinbase and many US-based exchanges are now keeping much better records to comply. The IRS has taken the stance that crypto-to-crypto trades are taxable, not just fiat-to-crypto trades. The burden of record keeping and tax compliance is on the individual.

Many people believe that trading in crypto is anonymous and untraceable, but that’s not entirely correct. If you have traded on exchanges or popular public blockchains like ETH and BTC, then there is a trail. In the event that your crypto has gained value since purchase, you’ll need to track its cost-basis and pay capital gains tax on the growth in your investment when you convert it to another fiat currency or cryptocurrency.

So, the IRS cares about crypto taxes. Record keeping and accounting when you are trading crypto can get really messy. ZenLedger is built to simplify all that for you.

With that, here are some important tax tips that you should consider with the help of your tax professional:

Tax Loss Harvesting and Wash Sales

If you want to capture a tax loss asset, make sure you sell before Dec 31, 2018. You must realize a capital loss in this accounting period or the chance is gone.

You can only capture a tax loss asset when you have realized a loss. It doesn’t matter than you bought BTC at $10,000 and it’s now at $4,000. If you don’t sell at $4,000, you will not realize the loss, and you will not receive any benefit from an IRS, tax accounting point of view.

Additional benefits are that you can put these net losses against net gains you have from other investments — like stocks. You can also deduct up to $3,000 from your income tax return from your capital losses. Below are a couple examples of how you might take advantage of tax loss harvesting:

If You Have A Diversified Portfolio (Tax Loss Harvesting)

If you recognized gains on other assets this year (like stocks you sold) and you owe the IRS capital gains taxes on those sales, you can write off of those capital gains taxes if you can show losses on another asset (like crypto).

Example: You owe the IRS $8,000 in taxes for profits you made when you sold your stock in Company ABC in June of this year. If you sell some of your crypto at a loss you can offset that tax debt and capture a tax benefit. If you sell coins at a total loss of $8,000, you will owe the IRS nothing for capital gains. Savvy traders do this all the time.

If You ONLY Invest in Crypto (Wash Sales)

Take advantage of a wash sale — the selling of coins at a loss, and then immediately buying them back — so that you can write off up to $3,000 against your normal income tax. While we know that crypto is less and less of the “wild west” each year, this is an area where regulations applied to stocks have not yet been applied to crypto.

This does not mean other cryptocurrencies are not or will not be categorized as securities eventually. In fact, given recent SEC action to prosecute ICO issuers for selling unregistered securities, it’s clear some cryptocurrencies are considered by the government to be securities. While the IRS may expand section 1091 to include Bitcoin and Ethereum at some point in the future, most experts agree crypto investors can claim losses on coins they sell and buy back without waiting 30 days. But if you are selling now and buy back on or after Jan 1, 2019, you are in the clear either way, as a 30-day rule is nullified by the end of the tax year.

ZenLedger’s Tax Loss Harvesting Tool

ZenLedger has just launched a tax loss harvesting tool. If you go to ZenLedger, you can start your account for free.

ZenLedger’s Tax Loss Harvesting Tool

These rules are provided by the IRS to help traders who have taken a loss. The rules are there for you to use when your investments are going against you. Securities markets have a rule (IRC Section 1091) prohibiting traders from buying back into a position the trader recently sold within 30 days of the sale- called the Wash Rule. Most tax experts agree that this does not apply to crypto, since IRS guidance pegs cryptocurrency as property. Please consult your own tax professional.

Keep Records!

Seriously, while this may seem like a no-brainer, it will save you lots of time and effort when it comes time to calculate your yearly results. The best time to start keeping good records is today.

Some exchanges will only let a user download the last three months of trades, in which case you may want to check in quarterly and download your transactions. If you haven’t been downloading quarterly, you may have to download multiple files adjust your date range. For example, first download September 1st through December 1st, then July 1st through August 31st, then April 1st through June 30th, etc. Alternatively, using API keys can help you import all the data with much greater ease.

Some wallets create a new address for every trade. If you want to do this for security purposes, go for it. But if you don’t actually want to do this, you can likely change the settings on your wallet to keep the same address for each transaction and this will simplify your accounting.

So you’ll want to set some calendar reminders to go and grab your records. If you conduct OTC trades, mark that down in a spreadsheet. If you lose some crypto on a wallet or donate to charity, record that.

FIFO v. LIFO

Among the primary confusions in the crypto tax world are the implications of the IRS’ designation of cryptocurrency as property, and how this applies to calculating gain or loss. The property designation leads many investors to believe you have the choice of applying either FIFO (first in, first out), LIFO (last in, first out), or lot-specific identification to determine what your net capital gain or loss is. But IRS actually gives no further guidance beyond designating crypto as property.

The CPAs we have talked to strongly recommend FIFO accounting. They do not feel that LIFO accounting is clearly defensible for crypto.

The problem with applying LIFO to your calculations is (at least as it applies to stocks) LIFO and lot-specific identification are only allowed in cases in which you can “adequately identify” the specific lot to be sold. Because adequate identification requires being able to specify exactly what is being sold, and there isn’t anything tangible about cryptocurrency (in the way for instance, a stock certificate represents a share of stock), it’s likely adequate identification isn’t possible. (See Treasury Reg.1.102–1(c)(2)-(4) for more information).

In Conclusion

Legislation around the crypto tax industry remains murky, so it’s valuable to gain as much guidance as possible from qualified tax advisors with experience in cryptocurrency, as well as support from seamless tools for helping you track and manage your crypto, such as ZenLedger.

By taking advantage of opportunities to reduce your tax burden this year, you’ll be primed to make the most of whatever 2019 has to offer in cryptocurrency.

~Team ZenLedger

***Update 1/9/2019 — Find out more about ZenLedger (or leave a review) on ProductHunt.