This is essential to calculating profit and loss. The value of the cryptocurrency, both on the day of acquisition and the day it was used to get a service/product or exchanged for money or other cryptocurrencies, is to be recorded.
The next step is to determine if the crypto activity falls under any of the taxable events discussed in the earlier section.
Using the value computed in Step 1, the tax liability can be calculated. For instance, if cryptocurrency was purchased for $1000 and utilized/sold when the market value was $800, then it means there is a loss of $200. (Fair market value - Tax Basis= Profit/Loss)
Any loss incurred on cryptocurrency dealing can be used for offsetting capital gains. Losses that do not apply to offset capital gains are deductible from other kinds of income. This has a fixed limit of $3000. There are provisions to carry forward losses as well.
Form 1040, Schedule D is where income coming from Bitcoin and other cryptocurrency dealings is reported. Based on the nature of the transaction, the type of income that is made from cryptocurrency can vary- capital gain or ordinary income. It must be reported in the appropriate columns of the form. IRS Form 8949-D, used for reporting the disposal and sale of capital assets, is where all details of cryptocurrency transactions are to be filled.
After gathering the relevant data to generate a tax report, the next step is to file the tax report.
Once the tax basis and liabilities have been assessed, using the above steps, filing the taxes is the next step. For this, there is, also, a simple 5-step process to be followed, which is highlighted below.
The first step is to evaluate cryptocurrencies held with the market values on the day of acquisition and redemption. These details go under Schedule D of Form 1040.
Analyzing a cryptocurrency portfolio is easy, if assets are only in one crypto, like Bitcoin or Ethereum . However, if the portfolio is across multiple cryptocurrencies then the first step is to be done for each one. Most cryptocurrency exchanges have sufficient capabilities for portfolio analysis and reporting. There are many portfolio management products explicitly designed for cryptocurrencies.
With all the raw data in place, the next part involves organizing the different transactions. A few other points in addition to what has already been covered about taxable events are below:
Cryptocurrency received as a payment for providing a service or product is reported as regular income . It incurs Federal Taxes as well as State Taxes (depending on the taxpayer's state of
Bitcoins that are received by mining are taxed as ordinary income . The same goes for cryptocurrencies derived by airdrop or hard-fork exercise . Self-employment tax may be applicable in the case of mining, depending on the state of residence.
Bitcoins bought for an investment and sold at a profit are taxed depending on the holding period. If it is less than one year, then it is taxed as ordinary income. If the holding period is over a year, then it is treated as capital gains with a 3.8% additional tax on the investment income.
Donations, in cryptocurrencies, to eligible charities qualify for tax exemptions .
After classifying transactions and evaluating capital gains, assessing taxes and ensuring compliance is key to creating a tax strategy. The 3 things to remember here are:
Calculating holding periods accurately
Account for all losses
Keeping a tab on any notification/rules laid down by the IRS
For-profits, it is always better to convert the cryptocurrency to dollars rather than another cryptocurrency. Taxes will be levied either way, so it is better to have some real currency to pay taxes on. However, this can differ depending on the total income, risk level, and goal with cryptocurrency investment.
Once all cryptocurrency data is stored and analyzed the tax report can be generated. Reviewing the report will help find other ways for saving taxes. For instance, holding cryptocurrency for over a year attracts capital gain tax, which can vary from 0% to 20% as per the tax bracket. On the other hand, cryptocurrency held for less than a year attracts tax around a 40% rate.
This guide should serve as a starting point in evaluating tax liability and paying taxes only on actual profits. Crypto-assets are likely to grow in the coming years- following the IRS's evolution on the matter will keep the US taxpayer on the right side of the law while earning profits.