How to Pay Tax on Cryptocurrency Trades

How to Pay Tax on Cryptocurrency Trades

Don’t cash out your Bitcoin until you read this.

There’s a lot of misinformation, and frankly, bad advice out there when it comes to trading cryptocurrency and tax. If you don’t do careful research, it can seem like the rules are regularly changing and that no one knows what they’re talking about.

However, if you’re in the US, the IRS has made its position crystal clear. Under the current interpretation of the law, every single cryptocurrency transaction is a taxable event. And even if you believe you’re a small fish, that the IRS will never be able to track you down, it’s simply not worth the risk. The IRS has been using software since 2015 to trace the movement of bitcoin. Do not put yourself in the position of getting in trouble with the IRS.

The problem is that even if you do know the rules, they can be hard to follow. This problem is even worse if you’re trading in between cryptocurrencies. If you want to do things the right way, you’ll need to record the market price of each coin you trade. From that, you’ll then need to report any gains or losses at the time of that trade. Keeping track of all of these trades gets cumbersome, fast – especially if you’re making more than a few a year. If we had to do this by hand, I’m sure most wouldn’t. There are a few tools out there, but I’m using Bitcoin.tax to take care of the problem for me.

What are cryptocurrency traders getting wrong?

A common misunderstanding held by traders is that you can just view your trades as a single transaction and report your net gains and losses when you file your taxes. For example, a trader might buy their Bitcoin with cash. Later on, they’d trade it for an altcoin like Golem, and wait for a while for the price to rise. Then when it’s time to cash out, they might trade their Golem back for Bitcoin and sell their bitcoin back for cash. After all of this, they’d report their net gain or loss from the entire string of trades.

However, this is an oversimplification and according to the IRS, is not how you should report these trades. Reporting in this way would be fine if the process were cash to Bitcoin and back, but it’s not. Each transaction where a cryptocurrency is sold is considered a taxable event.

In the example above, there are three taxable events. First, when the trader trades Bitcoin for Golem. Then, when the trader sells Golem is tradedback for Bitcoin. And finally, when the Bitcoin is traded for cash. It may help to think of the transactions between cryptocurrencies as immediately selling one cryptocurrency at market price and buying another with that money.

Each cryptocurrency is its own capital asset. You need to report any gains from when you bought it based on the fair market value of the cryptocurrency at the time you sell it.

An Example

Let’s imagine the transactions from the example above looked like this (prices are purely from my imagination):

A trader buys $3,000 worth of BTC. They wait a while and their BTC grows in value and becomes worth $4,000.

Then they decide that they want to put it all into Golem. The trader trades their $4,000 worth of BTC for $4,000 (Golem Network Tokens). This is the first taxable event, and the trader will need to report $1,000 of capital gains since their BTC grew $1,000 in value and are selling it now.

The trader then waits a while longer, and that $4,000 worth of GNT does very well, and grows to become worth $6,000. The trader then decides that it’s time to cash out and trades the $6,000 worth of GNT for $6,000 of BTC. This is, again, a taxable event and the trader will need to report their $2,000 in gains at the moment they sell their GNT.

They then wait a little longer to sell their BTC and it shrinks in value back down to $5,000. The trader then decides to cash out and sell their BTC for USD. This is also a tax reported event, but is reported as a loss of $1000.

Notice that I left out the exact number of tokens of each cryptocurrency in my example. This is because, as far as the IRS is concerned, the numbers of each currency don’t matter. All they care about is the fair market value, of the assets you trade. Specifically, you’ll need to report your gains and losses in market value of each asset at the moment of each transaction each time you sell a cryptocurrency — even if it’s for another cryptocurrency.

That’s a lot to keep track of. Luckily, there are tools out there to help with that.

How to report your cryptocurrency trades come tax season (the right way)

If you have any sizable volume of transactions, it would be incredibly cumbersome to go over each one by hand. You’d have to look up the fair market value for every cryptocurrency involved at each time you buy and sell. Once you had that, you’d need to calculate your net gains and losses. Fortunately, there’s Bitcoin.tax which promises to do all the work for us!

Bitcoin.tax‘s pricing seems fair enough — free for light traders (up to 100 trades) and $20 per year for heavy traders (those who go over).

Importing Trades

You have the option to add trades by hand. But, it’s far easier (and less error prone) to import your trades automatically using the tools provided by Bitcoin.tax. They can connect safely and directly to your exchange accounts and import your trades for each tax year.

As you set this up, read carefully and make sure you grant read-only access to your accounts! I’m sure the people at Bitcoin.tax are stand-up people. However, you still should only grant the access necessary for the job. The automatic imports will work for most exchanges like GDAX (& Coinbase), Kraken, and Gemini. For other exchanges, like Poloniex, you’ll need to download your complete trading history (see screenshot) and upload it.

Poloniex Cryptocurrency Trade History
In Poloniex, you’ll need to visit your Trade History and download your “Complete Trade History”

 

Make sure you connect each exchange and supply the site with your entire trade history. You’ll need to do this for your reports to be accurate.

Bitcoin.tax also has support for tracking your direct cryptocurrency spending, and income from other sources like mining, and lending. However, that’s outside the scope of what I’ll cover here.

Pulling Data Out

After supplying Bitcoin.tax with all the information about your trades, you’ll be able to get use out of their reports!

Capital Gains Report Summary
An example capital gains summary report from bitcoin.tax

Head over to the “Reports & Export” tab. Here is where you’ll need to go when it’s time to pay your taxes. There you can download a complete Capital Gains Report for the fiscal year. You’ll have a few options to download your data. You can download your data as a CSV which will be compatible with most software with a little shaping. Or, you may download it as a Form 8949 Statement, or formats specifically for TaxACT or TurboTax. From there, you can import the report into your tax software or use it as you fill out your taxes.

Final Thoughts

Overall, I’ve been pretty happy with Bitcoin.tax. Especially since I set up my trading bot, with the number of trades I’ve made, there’s no way I would have been able to report them all by hand. Plus, it can handle my other source of cryptocurrency income – lending! However, it does have some fierce competition. There’s also CoinTracking out there which seems to be a bit more full featured with its reporting features, but that’s also anywhere from $130-300 / year. For the price, I don’t think it can be beaten.

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