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Navigating the Perils of Cryptocurrency Taxes

Rain Carlson
Rain Carlson
Cryptocurrency tax rules contain many gray areas that may open the door to mistakes. This article explains various cryptocurrency tax challenges.

The meteoric rise of cryptocurrencies like Bitcoin, Ethereum, and Dogecoin created a new class of investors who are now grappling with the complex tax implications of their holdings and transactions. With the IRS closely tracking crypto activity, it’s essential to comply with tax rules to avoid penalties or audits.

Read on to understand the key challenges in reporting cryptocurrency taxes accurately and why working with an accountant experienced in crypto taxes can optimize your tax position.

While the IRS treats virtual currencies as taxable property, there is limited formal guidance around some specifics of crypto taxes. Gain clarity on key areas where ambiguity may exist:

  • Cost Basis tracking - Determining an accurate cost basis can be when difficult when transactions span across multiple exchanges and wallets. Therefore, it is imperative to establish a cost reporting system that addresses the fundamentals of tax reporting.

  • Type and Frequency of trading - Active trading may look more like a business whereby cryptocurrency receipts would be treated as ordinary income rather than as capital gains. Determining how and where you trade serve as the basis for tax reporting.

  • Tax forms - Many Exchanges are not required to issue tax forms such as a Form 1099, leaving the reporting burden on individual investors.

  • Tax category confusion - Is a coin a capital asset, commodity, or collectible? Each has different tax rates and rules. Some coins provide utility while others offer equity-like rights.

  • Air drops, tipping, and mining - Free coins received from promotions, mining, or other activities should be reported as income equal to the fair market value upon receipt. Many investors incorrectly assume these are tax-free.

Without clarity on these key areas, investors risk incorrectly estimating taxes or even failing to report crypto-related income streams.

The Crypto Tax Crackdown

In a recent survey, only 0.04% of tax filers reported cryptocurrency gains. With billions in profits generated, it’s clear most investors are not properly reporting crypto income.

For peace of mind, cryptocurrency investors need an expert guide through proper reporting of their complex activities across exchanges, DeFi protocols, NFT marketplaces, digital wallets, and more.

Why a Crypto Tax Pro is Worth It

Hiring a crypto-experienced tax professional maximizes deductions legally available to crypto investors while avoiding missteps. The right advisor is proactive about:

  • Tracking cost basis across wallets – With many exchanges and transfers, cost basis can be lost, resulting in the over-reporting of capital gains. A tax professional can help you track and document the cost basis and fair market value at the time of transactions.
  • Classifying assets – A tax professional can help you determine if coins are capital assets eligible for preferential long-term capital gain rates or if they represent non-capital assets that generate ordinary income. This classification directly impacts tax rates applied.
  • Tax minimizing strategies – Deciding on what to sell and when to sell may reduce taxable income from crypto investing activities. Consulting with a qualified professional may prove to be invaluable to your portfolio holdings.

What to Ask a Prospective Crypto Accountant

As crypto tax rules rapidly evolve, it’s essential to vet an advisor’s qualifications in this unique niche. Key questions to ask:

  • Have you handled cryptocurrency tax preparation and reporting?
  • What accounting rules are important in cryptocurrency?
  • Will you manage and document cost basis across wallets or is that my responsibility?
  • Do you take conservative or aggressive stances when the tax code is unclear?
  • What are your fees for tax preparation and ongoing advisory services?

The Bottom Line

Be sure to use a cryptocurrency transaction tracking system that encompasses cost basis, sales basis, and dates these activities took place. If you have a very active crypto account, your best bet is to use a software designed for keeping track of your investment activities.

Without proper counsel, it’s easy to misreport cryptocurrency activities and transactions.  Now is the time to work with a crypto-savvy tax expert to ensure you stay on the right side of the tax code. Don’t delay – consult an advisor today so you can invest in crypto with confidence knowing your taxes will be done right.

Check back here for further crypto related articles, what to know about cryptocurrency and, much more.

Rain Carlson
Written by

Rain Carlson

I help business owners get peace of mind through best accounting systems implementation, strategic planning and tax services, empowering clients to focus on the growth and development of their business and make well-informed decisions.