Let’s face it: doing your crypto taxes can be a drag with all the complexities, from the evolving crypto landscape to the obscure regulations. It’s hard to keep up with what is happening, leaving crypto taxpayers vulnerable to IRS audits and penalties. There are a plethora of mistakes that can occur and misconceptions that taxpayers have, which could cause a more significant tax burden than necessary. As crypto assets gain popularity, it is important to be diligent in reporting digital assets, as they can have significant tax implications.
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Failing to Report Your Crypto Activity
There is a common misbelief that your crypto transactions are concealed from the IRS, which leads to the false thinking that crypto activity does not need to be reported on your tax return. The IRS is currently pushing crypto exchanges to report their US users. They have also been issuing subpoenas to crypto exchanges to provide a list of their US users and their transaction history, like Kraken was ordered to do in June 2023. Furthermore, the blockchain is an immutable ledger that stores all cryptocurrency transactions. With the information provided by these exchanges, the IRS may be able to identify US taxpayers on the blockchain. You have a reporting obligation for all crypto transactions, including crypto-to-crypto (stablecoins included) and crypto-to-fiat trades, even if you don’t convert them into cash. This costly mistake can result in paying interest and penalties on your unreported tax liability, not to mention the costs of defending yourself in an audit and resolving your tax issues with the IRS. The best way to protect your crypto holdings is by being tax-compliant.
Not Filing Your Crypto Losses
It is the bear market, and you don’t report your crypto losses. So what? Well, cryptocurrency losses should still be reported, as they can provide a future tax benefit. Although capital losses are limited to $3,000 to offset Ordinary Income (wages, interest, rental, etc.), any remaining losses can be carried forward indefinitely to offset future capital gains. The $3,000 capital loss limitation does not apply to current or future capital gains; they can be used to offset gains from stocks. To claim these capital losses in the future, you need to calculate the losses and report them in the year they occur.
Putting Full Trust in a Crypto Tax Software
Online crypto tax calculators will have you believe that you can export your crypto tax reports accurately in just minutes. In most cases, this is far from the truth and requires a lot more time and effort than what needs to be done by the user. The general steps to calculating your crypto gains include importing your data, ensuring that the data was imported correctly and completely, classifying all transactions, addressing errors, addressing missing cost basis, and verifying that the tax reports are accurate. The user does much more work than these crypto tax software advertise as they do not classify all the crypto transactions for you and may not always import transactions correctly. In addition, all these software have disclaimers on their tax reports or websites stating that these reports are not to be used for tax or legal purposes. They take no liability for what they are providing. It is the taxpayer’s responsibility to ensure that they are reporting their crypto income correctly.
Every situation is different. If you feel over your head, schedule a free consultation with our expert team of crypto tax accountants to help with your crypto tax filings.
Missing Crypto Transactions
Many crypto traders have used multiple exchanges for investing and trading cryptocurrencies. Often, exchanges go out of business or lock out US citizens from their platforms, making it impossible to get trading transaction history. Restructuring trading data from memory can be futile and inaccurate. As best practice, it’s recommended to periodically download transaction histories as you use cryptocurrency exchanges to have all the correct information for tax filing. The responsibility to keep detailed records of crypto transactions lies with the taxpayer.
Unreliable Exchange or Blockchain Data
More reliable data is needed for both taxpayers and crypto tax professionals alike.
Cryptocurrency exchanges are in the business of keeping their trading platforms running smoothly to allow their customers to continue trading. They do not always use best practices to record their user’s trading data. This, along with the lack of record-keeping guidelines, leads to transaction histories with errors. This can cause issues when reporting taxable transactions on your tax return. For example, KuCoin omitted transactions from API and CSV trade histories a few years ago. This caused users to have issues with missing cost basis in their crypto tax reports that they had to solve on their own. Taxpayers may need to keep their own record of trades they can use to verify the transaction data provided by the exchange.
Some blockchains are not optimal for providing transaction data for reporting crypto income. It can be challenging to download the information to import into the crypto tax calculator. For example, many crypto tax software claim that they import Solana transactions; however, we have noticed errors or missing transactions in many of these software. We recommend taxpayers who trade or earn rewards directly on the blockchain and decentralized exchanges keep their records of their transactions for tax reporting.
Missing Cost Basis
A common problem taxpayers face when calculating their crypto capital gains is missing the cost basis on sold cryptocurrencies. Generally, this means that the crypto tax software shows no purchase history or is missing the purchase history for the sold asset. This causes an overstatement of taxable income, thus increasing taxes owed. This could result from missing records or an error in the calculation.
If you have yet to import the trading histories from all your accounts, there is bound to be missing cost basis. Go through the crypto transaction data that you have and make sure everything is imported into the software. If you are missing transaction information or cannot retrieve it, you may need to reconstruct your trading history to find the correct purchase cost.
Missing cost basis could also result from incorrectly importing data into the software. Double-check that all information was imported correctly and that there are no mathematical errors or typos. If you imported transactions using Excel or CSV files, ensure the appropriate time zones were used to update the files. If you imported two separate Excel transaction histories, you may be reporting sales of cryptocurrencies before the purchases if they occurred on the same day. For example, if you purchased 1 BTC on Kraken at 1 pm and sold it on Coinbase on the same day at 4 pm, the trades should reflect this in the software. If the purchased transactions are shown as occurring after the sale in the software, you will have missing cost basis.
Missing cost basis may also result from erroneous transaction classifications or unclassified transactions. Make sure all transactions are classified correctly. In some crypto tax software, you need to identify connected withdrawals and deposits and classify them as internal transfers, which are non-taxable transactions. If these are not addressed appropriately according to the software, they may have an adverse impact on the tax reports computed by the tax calculator.
Not Reporting Staking Rewards and Other Crypto Income
Crypto investors must report more than just their capital gains or losses from trading. Staking rewards or other crypto income from interest, crypto mining, or crypto gaming, among others, are taxable events and should be treated as taxable income upon receipt. These are considered ordinary income, not capital gains. They will be taxed at your ordinary income tax rates. The amount reported as income on the tax return will equal the Fair Market Value in US dollars of the tokens at the time of receipt. Paying attention to this throughout the year is vital as income is received. If the value of the tokens drops, taxpayers are still on the hook for paying income tax on the value of the tokens when they receive them, even though they may have depreciated. It may be necessary to convert a percentage of digital assets earned to fiat to set aside any tax liability that is incurred. Although there may be various tax treatments for the different types of crypto income, always seek the counsel of a tax professional before applying other methods.