Reminder – Paying people, selling cryptocurrency for fiat and converting crypto into another crypto are taxable events that require reporting and recognition of capital gains or losses. Cryptocurrency is treated as property for tax purposes and general property treatment is applicable in determining the tax implications.
Plan well to figure out where you stand and if you might have a potential tax liability. On more complicated matters involving cryptocurrency, consult a tax professional.
Take advantage of the losses
At a glance – the entire cryptocurrency market is down around 90% from its all-time highs seen in early 2018. Take advantage of the losses, which are used to offset capital gains and up to $3,000 of ordinary income if applicable.
- If your 2018 capital losses exceed your capital gains even after the $3,000 ordinary income deduction, you will have a carryover loss that can be used to offset gains in future years.
- Crypto losses can be used to offset capital gains from other sources as well. Remember that Long-Term Capital Losses can offset Short Term Capital Gains and vice versa.
Lack of economic substance
The wash sale rule doesn’t apply to cryptocurrency. However, there might be an issue of “lack of economic substance” when you decide to recognise a loss by converting or selling your crypto for tax purposes and buying it right back. So allow reasonable time before converting/buying back into the desired tokens or cryptocurrencies.
It even makes sense to wait 30 days, as the wash sale rule places a 30-day time limit on repurchasing back the security sold at a loss. Even though there is no official language of cryptocurrency being a security, cryptocurrencies do have security-like liquidity and volume of trading, so in the eyes of IRS the wash sale rule may be extended to include cryptocurrency transactions.
Tip- Compare the beginning and ending balances
The challenge at the end of the year is to compute gains or losses if you had hundreds of transactions on various exchanges. The IRS Notice 2014-21 states that every single transaction mentioned in “Reminder” paragraph above requires reporting and recognition of capital gains and losses. But practically, it is unreasonable to spend days on picking out each transaction on every single exchange when we are talking about hundreds of transactions. It is more reasonable to compare the beginning and ending balances on each exchange used and realize a gain or loss at the end of the year by converting the whole account into another type of crypto and then back into your desired crypto (be mindful of the wash sale rules).
Steve deposited 1 BTC (purchased for $1,000 on January 1st, 2017) on Bittrex on January 5th, 2018, when bitcoin is at $17,000. He traded with this account for the entire year, and now, let’s say Steve’s account is worth 1.5 BTC at a current rate of $3,000. Let’s digest what happened on the tax side:
- January 5th, 2018 – He started trading other tokens with the entire 1 BTC as soon as he deposited them – it’s safe to assume that he made a $16,000 long-term capital gain. ($17,000 – $1,000 basis, held over 1 year).
- December 31, 2018 – by this time Steve had been trading back and forth, resulting in hundreds of transactions in his Bittrex account. As if now his account is worth 1.5 BTC at $3,000. To simplify reporting – recognize a loss by converting all the tokens and cryptos within this account into anyone crypto, say BTC. This way, at the end of the year Steve had a $14,000 Short-Term Capital Loss ($17,000 basis – $3,000 BTC value).
- His net gain for the year is $16,000 Long-Term Capital Gain – $14,000 Short-Term Capital Loss = $2,000 Long-Term Capital Gain.
This technique is called loss harvesting and it’s very useful in crypto trading, especially during Bear market.
If you have been Hodling cryptocurrency for years and even the current prices are above the levels at which you bought in, consider doing the same conversion, but only to recognise a capital gain and step up your basis in crypto (We all hope that crypto will eventually go back up, so when you sell for higher prices in the future, your basis will be higher which will result in lower taxes on capital gains). This is only advantageous if you qualify for the 0% capital gains rate.
For singles this rate tops out at $38,600 ($77,200 MFJ) Taxable Income. Basically, if you earn $20,000 of taxable income in 2018, you can potentially realize $18,600 of Long Term capital gains that qualify for the 0% tax rate.
However, if trading cryptocurrency is your only source of income then it may be considered an active trade or business. Capital gains generated from day-to-day trading of cryptocurrencies will be taxed at a taxpayer’s ordinary income rates and the 0% Long-Term Capital Gains rate will not be applicable.
Start planning now and don’t wait until the last minute. Also DYOR– Do Your Own Research for in-depth calculation.