Why Cost-Basis is so Important for Doing Crypto TaxesJun 23, 2022, 6:22PM
With the rapid growth of the crypto market, the government certainly wants its share of the income produced by its citizens.
The cryptocurrency market has grown exponentially over the past several years. According to CoinMarketCap, as of June 2022; the market cap has grown to nearly $1 Trillion from July 2020 of $300 Billion! This rapid growth emphasizes how the government wants its share of the income produced by its citizens for bearing the risk of such investments.
While many investors use Bitcoin or other popular coins like Ethereum for their investments, others choose less well-known digital currencies such as BAT (Basic Attention Token), Dogecoin, and other altcoins. Some investors may be interested in investing in tokens that offer them unique benefits—such as privacy—while others may simply want to invest without any particular goal in mind. Whatever your reasons, it’s important to keep track of these transactions so you can report them on tax forms. In the USA, most cryptocurrency transactions are taxable events! Gone are the days where Bitcoin was $100 and most cryptocurrency resulted in negligible gains or losses.
This article will explain how to track and do crypto taxes. We'll also provide suggestions on reporting income earned from trading crypto assets on federal return 1040 Schedule 1. If you're looking to learn about tracking taxable events for cryptocurrency, check out our cryptocurrency tax software review. As always, this is a basic understanding needed to gather the information required. All taxes and accounting should be discussed with a licensed professional, such as an accountant, and none of this article is financial advice.
How to track and do crypto taxes
There is no one way to “track” money because each person's financial situation varies based on his/her goals. Different software works for different people, many would These are common taxable events:
- Income (from airdrops, bitcoin cashback, LPs, etc.)
- Income from swaps (trades, etc.)
- Expenses (such as gas for swaps, mints, etc)
The following steps outline what you need to know when filing your 2020 federal income returns. Gathering all information related to trades, exchanges, and wallets is the first step for anyone.
Create A List of Exchanges Where Trades were Made
Creating a list of all the exchanges with transactions associated with your name is the most important. The exchange is where most of the trades happen. Many people use DEXes, and those count too. Most crypto tax software would be able to pick up DEX transactions by the affiliated wallet. It is crucial to export the CSV file for all transactions so the tax software can report the cost-basis for each asset and lot. Many people consider using Bitfinex for margin lending, but this advanced passive income strategy is not for everyone.
Make a List of All Wallets
Creating a spreadsheet of all wallet addresses used will help report cost-basis of lots transferred between these accounts. This is also helpful for maintaining a record of each transaction, type and date. The date is useful for determining the market value at the time of a transaction. Using Ethereum for gas can be a taxable expense, but if the cost-basis for the ether used as gas is less than the market value, it would be reported as a capital gain.
Most tax software is able to determine the cost-basis automatically when the transaction dates are recorded. With cryptocurrency, the market is 24/7 and global, with several exchanges. It is important to use the same source for the cost-basis and the same timezone to ensure consistency across platforms. When calculating gross profit, always convert crypto holdings held onto foreign markets into U.S. Dollars or whatever the local currency is of your locale. Doing so ensures that you accurately calculate your taxable gain earned from buying and selling goods —even if you never physically see the actual greenback bills.
Report interest income received from DeFi
Most people earn interest from banks or other institutions on their checking accounts. When paying for purchases using debit or credit card, you likely got charged interest along with your transaction fee. Depending upon how often you used your account, the total amount of interest paid throughout the year may exceed passive dividend earnings. Since interest is taxed, you must track it appropriately and label it as such. In many cases capital gains have lower tax implications than income
Identify Expenses incurred throughout the year
Like traditional businesses, individuals involved in the cryptocurrency business face myriad challenges when trying to record their daily spending habits. Fortunately, modern technology offers numerous ways to save receipts quickly and efficiently. These tools range from basic smartphone scanners to sophisticated software designed specifically to handle accounting tasks. Regardless of your preferred method, be sure to document everything properly so you won’t end up owing penalties later on.
Don’t forget to factor in state and city taxes
Depending on where you live, you may owe additional taxes on top of federal income taxes. State and municipal governments typically charge higher rates compared to states with fewer residents. Additionally, cities impose special assessments on property owners. Local jurisdictions differ widely in terms of tax rate structures. Accordingly, it’s crucial to consult with a licensed accountant and/or financial planner to determine the best course of action.
Cryptocurrency Taxes are Confusing and Difficult
Don’t give up! Monitoring the cost-basis, checking accounts, and accurate records are the critical components. Once all the transactions, accounts, exchanges, etc. are gathered. Interpreting the information is crucial. Even though many say cryptic taxes are difficult and IRS regulations are unclear.
Disclaimer: information contained herein is provided without considering your personal circumstances, therefore should not be construed as financial advice, investment recommendation or an offer of, or solicitation for, any transactions in cryptocurrencies.