By Constantin Kogan, Managing Director at Wave Financial Group
With the crypto summer underway, one of the concerns that many traders, HODLers, miners, lenders, and stakers might have is how to report their gains and losses to the tax agencies.
The Internal Revenue Service (IRS) in the US is determined to make crypto users pay their fair share of tax. In September, it was reported that the agency has set aside $625,000 to be paid as a bounty to hackers who can help crack the untraceable privacy token Monero. It seems the agency believes many are using the altcoin to evade paying tax.
To understand more about crypto’s taxation, I recently Interviewed David Kemmerer, the co-founder, and CEO at CryptoTrader.Tax.
First, I wanted to know how crypto is taxed in the US.
“The IRS treats crypto as property. One would report capital gains or losses on the asset class as they would for stocks or real estate,” he said.
He explained that if, for example, you bought bitcoin worth $100,000 and the value is double ($200,000) when you decide to sell, you will have a capital gain of $100,000, and you will pay a percentage of that to the tax agency.
It turns out that what you report and pay to the tax agency depends on two primary factors.
First, is whether the holding period is long term or short term. If it is long term, which is over a year, you are supposed to report capital gains (or losses). If the holding does not exceed a year, then you are supposed to report an income.
Usually, capital gains are charged a lower percentage than the income tax. Meanwhile, taxable events charged under the income tax regimes include airdrops, mining rewards, and interests.
The second factor is your income class. Those with higher annual income tend to be charged more than those with lower income. The exact percentages are a matter of policy that changes from time to time.
What if you gained and then lost?
What happens if you are charged capital gains, and then a short time later, you end up losing some value to market volatility?
For example, you received a mining reward and reported it as an income, but then turns out to have lost some value when you decide to dispose of it.
David says that you would have incurred a capital loss. That would actually be deducted against your ordinary income up to a certain threshold.
“Let’s say I mined bitcoin when it was worth $10,000, and I realized it as an income. A month later I sell it for $8000. That means I have a $10,000 income and $2,000 capital loss. As an individual, I can deduct up to $3,000 of capital loss against my ordinary income.”
There are challenges when trying to formulate an understanding of the obligations that a crypto holder has. “The rules are not 100% clear cut on how certain aspects of crypto need to be treated,” he explained, “Whenever we face a grey area, we often have to let our users decide how they want the items treated.”
What does he think the future looks like regarding crypto taxation, in the US in particular?
Looking forward, David believes the next big thing that is about to happen regarding crypto taxation is the IRS enforcing the 1099 information reporting requirements. Already some digital currency businesses, including Coinbase, Kraken, and Gemini, have been doing this voluntarily.
The exchange will send 1099 to the IRS when you reach a specified threshold of activity. This report states, in particular, the volumes of your assets as processed. The goal is to increase tax compliance.
“If the IRS has 1099 for your exchange activity, and they don’t see any crypto income that you’ve filed, that triggers a red flag,” David explains. “They will send you a letter asking why you haven’t reported crypto income they see you should have.”
Even when you use your crypto to pay for goods and services, you might be required to report the difference between when you acquired it and when you used it to pay for the service or good, either as a gain or a loss.
David Kemmerer and his partners founded CryptoTrader.tax in 2017 to develop a software solution that helps users determine what they ought to report for taxation purposes.
The inspiration to build this platform came from their experience as crypto traders trying to file taxes from huge volumes of transactions. While most exchanges provide reports one can use to determine what they should report, the information is fragmented especially as crypto traders use different platforms simultaneously.
“It is a simple to use tool where you upload your transaction history from different exchanges, addresses, or wherever else taxable events (disposing of your holdings) happens and it automatically balances between gains and losses to arrive at an overall net value.”
He was quick to clarify, though, that they are not in the business of convincing people to report their taxes. “That is the IRS’s job. We are simply a tool that you can use if you want to report your taxes.”