They say there are two sure things in life: death and taxes. Unfortunately, no-one gets to take a pass on either of these things. As Bitcoin continues to become more mainstream, and everyone and their gran has heard about it, the taxman has become more interested in it as well. Unfortunately, filing your taxes on cryptocurrency profits isn’t exactly easy and it’s enough to send even the most financially savvy person into a full-on tailspin. If you’re adamant you’re not interested in hiring an accountant for help, you’ll want to keep reading for a list of the most common cryptocurrency tax mistakes, and how to avoid them.
1. Treating Cryptocurrency as a Currency
Although cryptocurrency is technically a currency (it’s in the name after all), for federal tax purposes, it’s classed as property. Because of this, the tax principles that apply to property, apply to all virtual currency transactions as well. Instead of generating gains and losses with foreign exchange currency, gains and losses are generated from your transactions. And, just like with stock, these are categorized into both long-term and short-term amounts, with capital losses able to be deducted from capital gains.
2. Ignoring Cryptocurrency Transactions on Goods and Services
Whenever a cryptocurrency is used to purchase a good or a service, potentially triggering a gain or a loss, this is classed as a taxable event. If there is any difference between the value of the cryptocurrency between when you purchased it, and when you spent it, you will have either a capital gain or loss to work out. For example, let’s say you purchased one Bitcoin for $100, however, when you went to spend the Bitcoin, it was worth $150. Based on these figures, you have a short-term gain, which needs recording on your tax return. Daily syndicated crypto news can help you keep on top of the exchange rates so that you know when the best time to buy and sell is, but any time you buy or sell at a different exchange rate, it needs reporting.
3. Not Considering Trading Fees
When calculating your basis in crypto assets, you need to add commissions and related fees to the purchase price. You then have two options. If your business does not own the crypto-assets individually, these are then classed as investments, and you can deduct these fees from your taxes on Section C. If, however, your business owns the crypto-assets, any fees and commissions that you had to pay can be claimed as expenses. This can be done in Section A as an itemized deduction.
4. Not Accurately Recording Holding Period Gains/Losses
If you own a cryptocurrency for less than one year before selling or trading it, it is classed as a short-term gain or loss. Anything over this period is classed as a long-term gain or loss. If you are like most traders, you will be making transactions throughout the year, too, and this is where things get confusing. Cryptocurrency generally follows the first-in, first-out method, which means if you buy 100 Bitcoins on January 1st, buy another 100 on August 1st, and then sell 100 on September 1st, it will be the January 1st trade that is recorded as being sold. It is vital that you record these correctly on your tax return to avoid falling foul of fines. If you’re confused, hiring a tax professional is a wise idea.
5. Only Paying US Taxes When You Cash Out Cryptocurrency into Fiat Money
Even if you have never cashed out your cryptocurrency into fiat money such as US dollars, you still may have tax to pay. Both trading and using cryptocurrency are taxable events and the amount owed will be calculated based on the exchange rate at the time the event occurs. This applies if you traded Bitcoin to Ethereum and then Ethereum to Ripple, for example. You will realize short-term and long- term gains and losses every time you make a trade, and this all needs to be calculated on your tax return. Taxes aren’t only due when you cash out into US dollars or another fiat money currency.
It’s important to keep in mind that because every crypto trade is taxed, you could find yourself owing a lot of money to the IRS if you make great gains one year, and then the price of cryptocurrency falls drastically the following. While this is unlikely, it’s best to seek professional advice and ensure you keep enough money aside to pay your tax returns on time.