Welcome to the world of crypto taxes, where investors are finally starting to see black and white rules! It's crucial to understand the basics of crypto taxes to ensure you stay on the right side of the law, especially since the IRS is looking to crack down on crypto investors moving forward. In this beginner's guide, we'll break down the essentials in simple terms, making it easy for you to navigate the sometimes complex world of crypto taxation.
Here are some best practices.
This post is part of CoinDesk's Tax Week 2023. Jaimin Desai is the co-founder of Reconcile, a tax optimization platform helping investors, business owners and high-income earners pay less tax. He’s regularly written for WorkWeek, Bloomberg and CoinDesk.
Understand different transactions
Know the difference between buying, selling, and exchanging cryptocurrencies. Each type of transaction, particular in DeFi, may have different tax implications.
For example, swapping one cryptocurrency for another is treated as a traditional sale of stock. So just going from BTC to ETH, even without cashing out to USD, still requires you to pay taxes if your BTC has appreciated in value.
Another scenario that causes lots of confusion and pain is airdrops. Airdrops are typically taxed at fair market value of receipt. So if you were airdropped 10 BTC for a total price of $100,000 on November 10, your taxable income would go up by that amount immediately. Even if you sold those 10 BTC the next day for $90,000, you would still report income of $100,000 and a capital loss of $10,000. Since the IRS only allows you to deduct $3,000 of capital losses every year, in this scenario, you can roll over the remaining $7,000 in future years.
Also, the IRS recently announced that they consider staking rewards to be taxable once received. Therefore, if you were awarded 1 ETH last year for $900 but only were able to sell it today (for some technical reason) when the price is closer to $1,800, your taxable income will increase by the latter amount.
Be mindful of holding periods
Understand the concept of holding periods. The length of time you hold a cryptocurrency can impact your tax rate. Short-term gains (held for less than a year) are taxed higher than long-term gains (held for longer than a year).
Consider professional help
If the crypto tax world seems overwhelming, don't hesitate to seek professional advice. Tax professionals with crypto expertise can provide personalized guidance based on your specific situation and help you classify transactions properly to minimize your tax burden.
Stay transparent with the IRS
Honesty is the best policy. Be transparent with the IRS about your crypto activities. Failing to report accurately can lead to penalties and legal complications. The recent IRS budget included a carve out to specifically target crypto cheats so be mindful of underreporting.
Stay organized throughout the year
Instead of scrambling during tax season, stay organized throughout the year. Regularly update your records after every transaction to ensure you have a clear picture of what you’ve been buying, selling, staking or gifting. The more you keep track in the moment, the less work you’ll have to do during tax season. The best way to stay organized is to note the date, amount and purpose so that you can properly classify the transactions at tax time.
Learn from recent cases
Stay informed about recent court cases related to crypto taxes. The most notable development is that the IRS finally clarified that staking rewards are taxable once received. By definition, ‘received’ means when the taxpayer has control over the assets and is able to sell their rewards.
As you embark on your crypto journey, remember that staying informed and proactive is key. By following these best practices, you can navigate the world of crypto taxes with confidence. Keep in mind that much of crypto tax regulation is still being figured out, so staying updated on the latest developments is crucial to avoid penalties and overpayment.
Disclaimer: This information is provided for general informational purposes only and should not be construed as legal, tax, or financial advice. CoinDesk does not share the editorial content or opinions contained within the package before publication and the sponsor does not sign off on or inherently endorse any individual opinions.