Bitcoin taxes are becoming a hot topic after the IRS has cracked down on cryptocurrency investors over the past year. Last year alone, the IRS sent out more than 10,000 warning and action letters to individuals suspected of misreporting bitcoin capital gains and losses income on their tax returns. In this article, we’ll look at four tips that can help keep you compliant and in the good graces of the IRS.
1. Keep Accurate Records
The No. 1 tip when it comes to simplifying your bitcoin tax reporting is to keep accurate records. If you succeed in this, your tax reporting will be significantly easier and less time-consuming at year end.
To do this, you should keep records of the exchanges, wallets and all other crypto platforms you use. You should also keep complete transaction history records from these exchanges and platforms. The vast majority of exchanges and platforms out there allow you to export complete comma-separated values (CSV) transaction history files.
These files detail all of your historical buys, sells, trades and transactions that occurred on that specific platform. These files are great for tax reporting. Most can be imported directly into your preferred crypto tax software tool.
In addition to your exchanges, you should keep records of any cryptocurrency you receive as payment for goods/services, forks, mining rewards and any other crypto received outside of simply buying it.
2. Don’t Forget About Bitcoin Losses
Bitcoin and other cryptocurrencies had a fairly volatile 2019. If you incurred losses with your investments, it’s important to remember that these losses deduct from your taxable income. It is required to report your cryptocurrency capital losses on IRS Form 8949. These losses will actually reduce your overall tax bill for the year.
Many individuals think that if they lost money investing in bitcoin, they can simply ignore the losses. This is not true, and it’s important to file your capital losses with your tax return to avoid any issues down the road with the IRS.
3. Consider Which Gains And Losses Calculation Method You Are Using
After the IRS released its second tax guidance and FAQ on cryptocurrency in October, the agency made it clear that specific identification calculation methods for gains and losses can be used, assuming you can identify the bitcoin or cryptocurrency you dispose of.
In the past, many tax professionals and bitcoin tax filers have simply used the first in, first out (FIFO) calculation method where the first bitcoin purchased is the first that gets sold off upon disposal.
However, specific identification methods such as last in, first out (LIFO) or highest in, first out (HIFO) can be used to strategically sell off higher-cost bitcoin, thereby lowering your overall capital gains and reducing your tax liability. To use these methods, you need to be able to specifically identify your crypto assets.
4. Be Wary Of 1099-K Forms Received From Your Exchange
1099-K has become the de facto type of 1099 that exchanges like Coinbase send to qualifying customers in order to report cryptocurrency and bitcoin income to the IRS. These 1099-Ks are misleading and are not helpful for capital gains and losses tax reporting.
1099-K reports your gross proceeds from your exchange. Gross proceeds is an irrelevant number for bitcoin tax reporting because you need gains and losses numbers, not the raw total transacted.
Many accountants are not yet savvy on the intricacies of bitcoin taxes. It’s important to make your tax professional aware of 1099-K and how it differs from traditional the 1099-B you may receive from your stockbroker. If you are not careful, you may end up overpaying on your taxes when using data from a 1099-K.
With the tax deadline moved to July 15 this year due to COVID-19, you still have weeks to get your tax return together. These tips can help you make the most of tax season and simultaneously prepare for the future.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.