Five Costly Crypto Tax Mistakes to Avoid When Filing Your Taxes in 2023
Whether you're a casual trader or an experienced investor, crypto tax mistakes can be costly. Failing to report all transactions or not harvesting your tax losses are common mistakes that can lead to higher tax liability or penalties. Therefore, it's essential to have a basic understanding of cryptocurrency taxation. In this article, we explain the five most common tax mistakes made by crypto investors to help you avoid them and ensure your investments are profitable and tax-compliant.
Last Updated: May 16, 2023
1. Not Reporting Crypto Taxes at All
Crypto assets are taxable in the US. Not reporting your crypto can result in penalties, fines, and even legal consequences. Cryptocurrency transactions are not private. Any gains from trading cryptocurrency are taxable and subject to capital gains taxes, in the same way crypto income is taxable as ordinary income.
The Internal Revenue Service (IRS) considers cryptocurrencies as property for tax purposes, and failure to report gains or income from cryptocurrency can result in willful tax evasion charges, which is a criminal offense. It’s crucial to report any gains or losses from cryptocurrency, regardless of whether or not you cash out.
Those who maintain proper records, accurately calculate gains via platforms such as Accointing, and file their crypto taxes correctly would be in a favorable position should the IRS investigate their tax return. To ensure that you have a comprehensive understanding of cryptocurrency taxation, we recommend referring to our regularly updated guide on crypto taxes in the US. This comprehensive guide written by our CPAs contains all the relevant information you need and will help you understand the tax implications of owning and trading cryptocurrencies in the USA.
2. Failure to Keep a Record of Your Transaction History
Keeping accurate records of all your crypto transactions is crucial for accurate tax reporting. Not keeping a record of your transaction history could result in misreporting earnings or overlooking opportunities to reduce your tax liability. To avoid these mistakes, it's important to keep detailed records of all your trades, including the date, type of coin, amount, value at the time of the trade, and any associated fees.
As manually capturing this data would be a logistical challenge, Accointing’s crypto portfolio tracking and tax tool can automate all of this for you after connecting your wallets and exchanges via API or CSV. Our crypto tax calculator will let you visualize your entire crypto portfolio’s gains at a glance, track the total value of your crypto portfolio in real time, and keep accurate records of your transactions.
3. Thinking Crypto-to-Crypto Transactions Are Not Taxable
Many people mistakenly believe that taxes are only owed when cashing out cryptocurrency to USD. However, any crypto-to-crypto transaction is considered a taxable event according to IRS guidance. This means that when you exchange one cryptocurrency for another, you are disposing of one asset and acquiring another, and a capital gains tax event occurs on the original crypto asset.
When you trade one crypto asset for another, you sell one asset at its fair market value and immediately use those funds to buy another asset. The initial sale transaction is considered a taxable disposition where you must recognize any gains or losses. The second transaction of acquiring the second crypto is treated as acquiring it for fiat currency.
For example, if you acquired Bitcoin at a lower price than its current market value and then used it to buy another cryptocurrency, you would need to report this gain. Conversely, if you acquired Bitcoin at a higher price than its current market value and then used it to buy another cryptocurrency, you would report a loss, which can be used to offset other gains for tax purposes. Therefore, every crypto-to-crypto transaction is subject to capital gains tax and must be reported to the tax authorities to avoid any penalties.
4. Failure to Classify Your Transactions Correctly
You must classify your transactions accurately to avoid tax filing mistakes. Certain classifications have different tax implications, and misclassifying transactions can lead to inaccurate tax reporting, potential audits, or penalties.
At Accointing, we offer comprehensive guides to help you classify your transactions correctly, including our main classifications guide and our USA - specific classifications guide. These regularly-updated articles provide guidance on which classifications lead to a taxable event in the USA and help you avoid potential tax liabilities and penalties.
5. Missing out on the Benefits of Tax Loss Harvesting
Failing to optimize your crypto taxes with loss harvesting can be a costly mistake. Tax loss harvesting is a simple strategy that involves selling crypto assets with unrealized losses to convert them into realized losses. You can then claim these losses on your tax return to offset any short or long-term capital gains tax and reduce your overall tax liability. For tax purposes, you cannot claim a loss until you sell or exchange the asset with the loss, which constitutes a taxable disposal and allows you to recognize your loss. However, it can be challenging to determine which assets to sell and which are in a loss position.
The Tax Loss Harvesting Tool provided by Accointing by Glassnode makes this process easier. This tool organizes your coins by wallet and tax lots and shows you the potential tax impact of selling each asset. By using this tool, you can identify unrealized losses in your coins and sell the coins that will generate the most significant loss, thus minimizing your tax bill.
Crypto Tax Mistakes FAQs
Will the IRS know if I don't report crypto?
Contrary to popular belief, cryptocurrency transactions are not private and anonymous. All transactions are recorded on the blockchain, which is a public ledger that anyone can view. Even if you use a wallet that does not require Know Your Customer (KYC) verification, your transactions will eventually be linked to your identity when you interact with a KYC'd account. Moreover, services such as Chainalysis can trace many transactions on the blockchain.
Failing to report your cryptocurrency gains and income is not a good idea. Just because you did not receive a Form 1099 from an exchange or another party does not mean that the income is not taxable. The IRS has been actively collecting data on cryptocurrency users and investors, and they can penalize you for willful failure to report your taxable crypto transactions. It is always better to report your crypto accurately and avoid potential legal consequences.
How much crypto losses can I claim?
When it comes to claiming crypto losses for tax purposes, all capital losses can be used to offset capital gains. Short-term losses are used to offset short-term gains first, while long-term losses are applied against long-term gains first. You can then combine your net short-term gain or loss with your net long-term gain or loss to calculate your overall capital gain or loss. If you have a net gain, it will be subject to taxation based on whether it's short-term or long-term. If you have a net loss, you can deduct up to $3,000 of the loss from your ordinary income and carry forward any excess losses to future years indefinitely.
I had funds in FTX. Can I get tax relief?
If you sold or traded your coins, any gains or losses must be reported like any other trading gains or losses. However, if you still own the coins but can't access them due to bankruptcy proceedings, such as with FTX, you can't currently write them off based on current tax laws. It's important to note that customers with funds on FTX aren't considered to have lost all of their funds and are considered creditors in the bankruptcy case. While it's expected that customers will recover some amount, it's unknown how much they will recover after other creditors are paid. As a result, taxpayers haven't realized the total loss yet, and the amount of the loss will remain unknown until the bankruptcy proceedings are finalized, which could take over a year.
For a detailed understanding of the FTX collapse, including its background, causes, and a timeline of events, check out our comprehensive guide. This will provide you with the latest updates and information on the current status of the FTX bankruptcy proceedings.