5 Most Common Cryptocurrency Tax Mistakes and How to Avoid Them
We are creating software that makes your accountant’s life easier and you safer. Consulting with leading CPAs like Charlie Minard of CryptoCPAs allowed us to design ZenLedger to client’s needs and specifications. Customer pain points became our pain points while we focused on what we do best in building software. We designed our software by running multiple sets of data and software against ours to see how to rapidly improve. We poured over tax law for thousands of hours. Then, we let the CPAs actually run the software with their clients to compare. These steps are critical as some tools capital gains are off by a factor of $10,000. Considering that the 1031 Exchanges employed in past years may no longer be claimed, perhaps even retroactively, we’ll all be able to correctly stitch together thousands of transactions and correctly classify them with your CPA and lawyer in one easy step. Even today, large tax software can handle only up to 2000 transactions. ZenLedger takes this arduous task that would take you, your CPA and their staff lots of time and resources into one easy step for you both.
While doing your taxes with software, Charlie and the CryptoCPA team gathered a few guidelines to get you started so you set the proper context. Avoid these 5 mistakes and you’ll see your estimations at a reasonable level going forward:
1. Treating Cryptocurrency as a Currency Instead of Property
For federal tax purposes, virtual currency is treated as property. Thus, general tax principles applicable to property transactions apply to all transactions using virtual currency. So, instead of generating foreign exchange currency gains/losses, capital gains/losses are generated from cryptocurrency transactions. Just like the sale of stock, capital gains/losses are categorized into short-term and long-term amounts and any capital losses can be deducted against any capital gains. Losses beyond that are deductible up to $3,000 annually.
2. Ignoring the Spending of Cryptocurrency for Goods and Services
A taxable event occurs whenever cryptocurrency is used to purchase goods or services, potentially triggering a capital gain/loss.
The difference (if any) between the cryptocurrency’s original purchase price (your basis) and the price at the time of spending is your capital gain/loss. For example:
You purchased 1 Ethereum (ETH) for $100 on 1/1/17
You spent 0.5 Ethereum (ETH) on 6/30/17 when the market price of ETH was $200
Your basis for the 0.5 ETH that you spent is $50 (0.5 * $100)
Your “sale price” for the 0.5 ETH that you spent is $100 (0.5 * $200)
Your capital gain is $50, and it is short-term since it was held for less than a year
3. Only Paying U.S. taxes at Cash Out into Fiat Currency
Trading between different cryptos (e.g. Bitcoin to Ethereum) will also trigger a capital gain unless a 1031 like-kind exchange election has been elected. Even if the taxpayer elects for their trades to be treated as like-kind, it is unclear whether the IRS will accept their position. If the IRS denies the claim for like-kind treatment, penalties and interest will be assessed on the outstanding tax owed.
4. Not including trading fees to increase basis and reduce taxes.
To calculate your basis in your crypto-assets, you add any related fees and commissions to the purchase price to arrive at the basis. These values should be included in the exportable csv files from your exchange. Any transaction fees incurred when sending cryptocurrencies between wallets could be considered investment expenses and would be deductible in 2017 on Schedule A as an itemized deduction. However, if instead of owning the crypto-assets individually, your business owns the cryptocurrency investments, you instead deduct these investment related fees on Schedule C (or the entity return).
5. Not accurately determining holding period Cryptocurrency gains, just like stock gains, are placed into short-term and long-term categories depending on their holding period.
Short-term: If you hold a cryptocurrency for less than a year before either trading It for another cryptocurrency or back into fiat, it is considered a short-term gain or loss. Long-term: If you hold a cryptocurrency for more than a year before either trading It for another cryptocurrency or back into fiat, it is considered a long-term gain or loss. The most conservative and common accounting method for handling cryptocurrency trades is the FIFO (First-in, First-out) method. Please consult a tax professional to understand how affects you. To talk to one of our CPAs about your specific situation, please reach out to us at firstname.lastname@example.org.
Founded by CPAs and cryptocurrency enthusiasts Charlie Minard and Andrew Perlin, Crypto CPAs helps its clients understand all cryptocurrency tax implications and works to take the uncertainty out of U.S. taxes. @CryptoCPAs