The following article is an exclusive contribution to CoinDesk's Crypto and Taxes 2018 series.
With tax season upon us, the meteoric rise of cryptocurrencies may become a double-edged sword for participants in the United States.
As crypto gained thousands of enthusiasts in 2017 and grew to a $400 billion industry, it also drew the eye of federal regulators.
Changes in our tax laws have already occurred. Effective this year, Tax Cuts and Jobs Act of 2017 excludes crypto-to-crypto trades from being treated as 1031 like-kind exchanges – a safe harbor long used by traders to defer taxable gains.
The prudent crypto individual or business must keep up with regulation and develop a process to organize information relating to buying and selling of digital currencies. Due diligence and documentation with accounting can act as a safeguard to show that your logic was in line with the most up-to-date compliance at the time of reporting.
Obviously adjustments will need to be made as regulations evolve, but proper preparation can go a long way.
Here are five steps to successfully include crypto in a bookkeeping system:
Don’t mix addresses
The reality of crypto is that you can receive and send payments from any multitude of addresses you create at will. Unless you are tracking each and every one of these addresses meticulously, this creates a pretty difficult job for your accountant, especially if you may also function as a business.
Do yourself and your finance team a favor: only transact for your business from addresses you deem to be “business-related.” Keep your personal expenses separate.
Of course, no one wants their complete records (whether business or personal) to be available in one neat (and public) address, but you can limit the time and effort spent accounting for your addresses by phasing in new ones on a pre-set schedule. Engage your finance team early; they are your best advocates.
Keep a running ledger of income/expense
Reported fiat values in the transaction history for tokens sent almost never line up one-to-one with agreed upon fiat values. Knowing this is the reality of blockchain transactions is important, but doesn’t negate the significance of tracking.
Record your transactions on your regular books as clearly as possible and keep an addendum ledger that specifically tracks your cryptocurrencies.
Each ledger for each currency should include information such as date; recipient or sender name; total amount of coin treated as income, expense or trade; the value at the time of the transaction; the transaction hash; a memo that states the kind of income, expense or trade that occurred (i.e. service income, perhaps a project name, etc.)
If you want to go the extra mile, you could have a register like this for each of your addresses.
Decide: FIFO or LIFO?
If you’re following the tip above and keeping a clear ledger of your assets, you should be able to easily track any gains or losses associated with paying your expenses using crypto or with trading one coin for another.
If you are outside of the U.S., however, the best rule of thumb is probably to stick with FIFO. Consistency and continuity from year to year is key, so don’t take this decision lightly and as always, consult with your advisors to find the most appropriate solution for your particular circumstances.
Take screenshots of transactions
You have to be able to provide supplemental evidence of transactions in receipt form, exactly like credit cards or bank statements.
The best way to do this, especially for large transactions, is to screenshot the transaction in addition to recording the transaction hash in your ledger.
Also include any additional invoices from vendors, customer contracts and/or supporting emails. This is important for accounting continuity if you have any personnel changes or any outside party needs access to the records.
Know where the money comes from
Transact in good faith with other, verifiable parties. Use common sense and don’t deal with organizations or individuals who don’t measure up to scrutiny, whether in fiat or crypto.
Most importantly, realize the public ledger is not enough. No one, least of all your accountant, wants to scramble to reinvent your financial wheel.
Be proactive in your crypto financial controls and recordkeeping. It’s the best way to play by the rules – even if all the rules don’t yet exist.
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