For most taxpayers, assembling tax returns and filing is a painful process. For those who had crypto activity in 2021, the process can be even more troublesome.
Transfers between wallets are common for investors looking to interact with different products offered by crypto exchanges and decentralized protocols. This level of activity makes recording every taxable transaction difficult.
Miles Brooks is a Certified Public Account and is the Director of Tax Strategy at CoinLedger.
Crypto investors filing their taxes must know how to track cost basis, maintain good records of all original purchases and transactions, and report everything in U.S. dollar terms. This is all in addition to making decisions – oftentimes without IRS guidance – as to the taxability of certain gray-area transactions, due to the ever-evolving nature of the cryptocurrency ecosystem.
CryptoTrader.Tax (rebranding to CoinLedger), commissioned a survey and published a report that found that almost 25% of crypto investors who didn’t report crypto on their tax return said they didn’t know crypto was taxable. Another 20% said they didn’t know how to report their crypto activity.
Cryptocurrency tax reporting software can help ensure investors avoid IRS scrutiny, which has grown sharper in recent years as more people invest in digital assets. As you file this year’s crypto taxes, here are also three important, common-sense tips to help you avoid the IRS' notice.
Read more: US Crypto Tax Guide 2022
Exchanging your crypto for another crypto or for NFTs is a taxable event
The IRS considers crypto property, which means that if you sell or dispose of it for another digital asset, you have to report the transaction on your tax return.
A common misconception is that if you don’t trade crypto back to U.S. dollars, you do not owe taxes on any gain. But trading one crypto for another is a disposal event, which is taxable and must be reported.
This rule covers exchanging any crypto, such as ETH, for a non-fungible token (NFT). NFTs are applicable to the same rules as cryptocurrency. Note when you purchase an NFT, you do this most of the time by disposing of your ETH or another crypto. When this occurs you have taxable gain or loss on that ETH or other crypto that you’ve used to make the NFT purchase.
If you earned income from crypto and then later sold, you have two different taxable events
There are many different ways to earn crypto, including mining, airdrops, staking your coins or through earning interest. When you earn crypto in this way, you have ordinary income to report. The amount you report is the fair market value of the crypto you earned when you received it. You should report this income on your tax return on Schedule 1, as "Other Income." From there, if you decide to sell your earned coins, you will have a capital gain or loss, depending on how the price of your crypto has changed from when you earned it.
You won’t end up paying taxes on the same income twice. The income you report on your tax return from earning the coins becomes your cost basis in those coins – which reduces the amount of tax you pay when you eventually sell.
Know when to mark ‘yes’ to the front-page question about virtual currency
At the beginning of the tax return, front and center, there’s a question of whether you engaged in any transaction involving virtual currency. If you received crypto, exchanged your crypto, or disposed of your crypto in 2021, you must answer yes.
If your crypto activity was limited to strictly purchasing crypto, holding crypto, or moving crypto from one wallet or account to another that you own or control, you can answer no to the question.
Investing and transacting with cryptocurrencies comes with the responsibility of reporting your taxable crypto transactions on your return. And although crypto taxes can be complex, the tools available can make the process easier.
Read more: Crypto Capital Gains and Tax Rates 2022
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