December is the most popular time for strategic tax planning as investors of all types look at their cryptocurrency portfolio to assess and reduce their liability. So we asked CryptoTrader.Tax CEO David Kemmerer to answer Quadency users' most common crypto tax questions of 2019.
1. Can I harvest my losses to reduce my tax bill?
The single most effective way to reduce your crypto taxes is to engage in crypto tax loss harvesting. Tax Loss Harvesting is the practice of selling an asset at a loss to offset a capital gains tax liability. By realizing or “harvesting” a loss, investors are able to offset taxes on both gains and income. This is a tax reduction strategy commonly used in the world of stocks and securities as well as cryptocurrencies.
John buys $1,000 of BTC and $2,000 of XRP in a given year. While holding these investments, the value of John’s BTC rises to $1,500 while XRP drops to $1,700. John sells all of his BTC for $1,500.
Without Tax Loss Harvesting
Without harvesting his losses in his XRP, John has a $500 capital gain for the year from the sale of his BTC. John pays taxes on all $500 of this capital gain.
With Tax Loss Harvesting
Rather than continuing to hold his XRP, John can harvest his losses in XRP by selling before year-end. Capital gains and losses get summed together for the year resulting in either a net gain or loss. John’s net capital gain is now only $200 for the year ($500 - $300). In this scenario, John only pays taxes on $200 of net capital gains rather than $500.
This is a small scale example, but for certain cryptocurrency investors there can be immense tax savings to be had by strategically harvesting losses. Cryptocurrency tax software like CryptoTrader.Tax has tax loss harvesting tools built into the app to help you automatically identify your best savings opportunities.
2. How do capital gains and losses work with cryptocurrency?
In most countries, cryptocurrency is treated as property for tax purposes. In other words, cryptocurrency is subject to the same capital gains and losses rules that apply to other forms of property like stocks, bonds, real estate, and gold. This means that you need to report your gains and losses from your trades whenever you sell, exchange or otherwise dispose of your crypto. Simply buying and holding cryptocurrency is not taxable.
3. How do I calculate my capital gains and losses from my crypto trades?
To calculate your capital gains and losses on your crypto trades, apply the following formula:
Fair Market Value – Cost Basis = Capital Gain / Loss
Fair market value is simply how much an asset would sell for on the open market. Again, with cryptocurrency, this fair market value is how much the coin was worth in terms of U.S. dollars at the time of the sale.
Cost basis is the original value of an asset for tax purposes. In the world of crypto, your cost basis is essentially how much it originally costed you to acquire the coin.
You purchase 0.2 Bitcoin for $2,000 in April of 2018 and then sell it two months later for $4,000, you have a $2,000 capital gain. You report this gain on your tax return, and depending on what tax bracket you fall under, you pay a certain percentage of tax on the gain. Rates fluctuate based on your tax bracket as well as depending on whether it was a short term vs. a long term gain.
4. Why can’t my cryptocurrency exchanges provide me with accurate tax documents?
Cryptocurrency exchanges are generally unable to provide users with accurate tax documentation, and it's a big problem in the industry.
By the nature of the technology that exchanges operate on, users are able to send Bitcoin and other cryptocurrencies to wallet addresses separate from the exchange itself. An example of this would look like you buying Bitcoin through Coinbase and then sending it to a Binance wallet address in order to acquire new coins and assets.
Because you can send cryptocurrencies from one platform to another, the cryptocurrency exchange has no possible way of knowing how, when, where or at what cost you originially acquired that cryptocurrency that you sent in. The exchange only sees that it showed up in your wallet.
This means that anytime you move crypto assets onto or off of an exchange, let’s say Coinbase, Coinbase completely loses the ability to provide you with accurate tax information. This is because it has no way of identifying what your cost basis is in that certain cryptocurrency, which is an essential piece to figure out your capital gain or loss. Because they don’t have this information, they can’t give you any sort of report detailing this info. This is true of all other major cryptocurrency exchanges.
The solution to this problem is to leverage crypto tax aggregating tools to collect your data from all platforms to build your holistic tax reports.
5. Are there tools to automate crypto tax reporting?
Yes! Over the past few years, cryptocurrency tax software platforms like CryptoTrader.Tax have been built to address these challenges and make crypto tax reporting as easy as a few button clicks. Just import all of your trades across all of your exchanges and generate your tax forms that you can import into platforms like TurboTax or simply give to your accountant.
Thanks to the CryptoTrader.Tax team for sharing this guide with Quadency's users!