Cryptocurrency Taxes: The Ultimate Guide to Filing with the IRS (And How To LEGALLY Avoid Paying Them!) +Trading Tools
Welcome to Cryptocurrency Taxes: The Ultimate Guide to Filing with the IRS (And How To LEGALLY Avoid Paying Them!) +Trading Tools
By Kyle Rea
This is probably one of the most valuable blogs you can read in the entire cryptocurrency universe. Nobody wants to get the IRS up in their world, so I’ve decided to make this master guide for all those that have invested in cryptocurrencies or plan to in order to help you save TONS of time, MONEY and a potential audit from the IRS or even Prison Time! Please give this a read!
First things first, I am NOT a tax accountant or financial advisor and only giving you information that I myself know about, so always DYOR (do your own research).
This blog will help you save a ton of money, avoid getting audited by IRS (hopefully) and keep track of all (or at least most) your trades within the crypto space. While this is mainly geared towards tax payers in United States, it is helpful to all of those that must pay taxes in their respective countries, or to those that are looking for tools to help them put the tax info together. This blog well help you out in more ways that one.
This is what I’m going to explain within this blog:
1) How to Pay Your Cryptocurrency Taxes
2) How to LEGALLY Avoid Paying Taxes for Cryptocurrency Gains
3) An Amazing Software That Keeps Track of all Your Trades For You!
4) And a Special Surprise at the End!
So let’s get started:
It’s simply confusing to try to even figure out how to pay taxes in cryptocurrency investing, especially since it’s so new and many tax accountants or advisors still aren’t sure what to do, even the IRS isn’t. The laws in place are very wishy-washy themselves so many just ignore taxes for now. This may “benefit” you in the sort run but once the IRS has it all figured out, they do NOT FORGET the past. So it’s best to do things by the books or potentially suffer bankruptcy or prison time…
The whole idea was to leave behind the centralize world of government control and central banks but it seems that you literally can’t go anywhere in the world without paying for it in some way, shape or form.
How To Pay Cryptocurrency Gains Taxes: What Is Taxable?
The first step into understanding how to pay your cryptocurrency taxes is to figure out what events are taxable and with this, you’ll have to know what kind of asset the IRS considers cryptocurrency to be labelled as. The US government doesn’t see cryptocurrency as a dollar or coin or even monetary but instead sees it as a property (for now). This is how they will currently label cryptocurrency but as we see further adoption and more use case as an actual banking security or even utility, we should likely see this change to another asset class most likely.
IRS treats the cryptocurrencies like property assets so they are subjective to capital gains taxes. Every time the coin goes up in value, you must pay gains taxes on this. You must also pay taxes if paid in cryptocurrency as a payment or wage from a contractor or employer. This would be considered a standard income tax.
There are three taxable events that pertain to capital gains if you’ve bought, sold or traded cryptocurrency and are taxed within the full year from January 1 - December 31 of each year.
1.) Exchanging one cryptocurrency for another
2.) Selling Cryptocurrency directly for FIAT (USD)
3.) Spending cryptocurrency on goods or services (especially using a Crypto debit card)
4.) Giving cryptocurrency as a gift is not a taxable event for any gift under $15,000 (the recipient inherits the cost basis; the gift tax still applies if you exceed the gift tax exemption amount of $15,000)
5.) A wallet-to-wallet transfer is not a taxable event (you can transfer between exchanges or wallets without realizing capital gains and losses, so make sure to check your records against the records of your exchanges as they may count transfers as taxable events as a safe harbor)
6.) Buying cryptocurrency with USD is not a taxable event. You don’t realize gains until you trade, use, or sell your crypto. If you hold longer than a year you can realize long-term capital gains (which are about half the rate of short-term) if you hold less than a year you realize short-term capital gains and losses.
Understanding Capital Gains Taxes
Determine your Cost Basis
Now that you know when you must pay your taxes on cryptocurrency transactions, you must know the step-by-step process to doing so. Step 1 is understanding your holdings cost basis, which is how much money you put into purchasing the “property”. In cryptocurrency, it is purchase price and all other costs associated with investing in cryptocurrency (I.E. transaction fees or maker taker fees from exchanges which you have traded).
Here’s how to calculate those fees:
(Crypto Purchase Price + Other fees) / Quantity of Holding = Cost Basis
For example, if you invested $500 in Litecoin back in 2017 on Coinbase at a 1.49% transaction fee on the purchase. Your cost basis would be calculated as such:
($500.00 + 1.49%*500)/5.1 = $99.50 per Litecoin
Calculate your Capital Gain/Loss
The last step in calculating your capital gain or loss is to simply subtract your cost basis from the sale of the cryptocurrency you held.
Sale Price — Cost Basis = Capital Gain/Loss
In example, if you had sold one Litecoin a month later when the price doubled to $200 per coin this would be considered a taxable event (crypto to fiat trade) and you would calculate as follows:
200–99.50 = $100.50 Capital Gain
You would then owe the due percentage of that $100.50 gain to the government.
Determining Fair Market Value
This can be confusing when doing crypto to crypto trading to find out the Fair Market Value so let’s take a look at an example below to determine how this works.
If bitcoin was $10,000 and you purchased $100 worth including transaction and brokerage fees that leaves you with 0.01 Bitcoin. Let’s say a few months later you trade all your .01 Bitcoin for 0.2 Ethereum, how would you be able to calculate this trade? This all has to do with fair market value of bitcoin at the time of the trade…
If Bitcoin was worth $200 at the time this means 0.01 Bitcoin is worth $200 which gives you the proper info to calculate your capital gains:
$200 - $100 = $100.00 capital gain
So you would owe the government whatever % they require based off that $100.00 capital gain.
This capital gain law is very confusing and not entirely accurate as some traders have been trading FAR longer than the rules have been around and with the government not really understanding the full concept of how crypto functions, they wanted to put laws down asap to stop “unnatural growth” and movement of currency to this new asset market. Depending on how many trades someone makes during the year, this can be extremely confusing to track all the trades accurately and even more time consuming. (Good news, I have provided tools below to help you with this! But finish reading the blog first, please. :) )
Short-Term vs. Long-Term Capital Gains:
The actual rate of capital gains tax is decided on a number of various factors. The first being whether or not capital gain is short or long term gains. Short term is less than a year of holding and long term is a year or more of holding. If you just HODL (for a year or more) your taxes will be far less confusing. Short term capital gains taxes are calculated at the marginal tax rate (see below).
The marginal tax brackets are determined for a single filer like so: Let’s say you made $82,000 during the tax year, and you purchased Bitcoin six months ago for $10,000 including fees and commissions. Yesterday, you sold Bitcoin for $11,000, a gain of $1,000.
The $1000 raises your income to $82,000 for the year. Based on the marginal tax rate table, the first $500 of your gain is taxed at the 22% rate, generating $110 in taxes. The remaining $500 is taxed at 24% as it exceeds the $82,500 threshold. This generates $120 in taxes. In total, the $1000 capital gain would generate $230 in taxes for the year. This is the amount that you owe the government.
Long-Term Capital Gains:
For all of the HODL’ers, if you held your cryptocurrency for a year or more, you qualify for a lower long-term capital gains rate. The table below details the tax brackets for 2018:
The long-term rate is much lower and rewards investors if they hold, continuously, for a year or more.
Filing Your Crypto Taxes
You need two forms to properly file your crypto taxes: The 8949 and the 1040 Schedule D. You will list all trades onto your 8949 along with the date of the trade, the date you acquired the crypto, the cost basis, your proceeds, and your gain or loss. Once you have listed every trade, total them up at the bottom, and transfer this amount to your 1040 Schedule D. Include both of these forms with your yearly tax return.
For a detailed layout of this process, see our article about the crypto tax reporting process.
What about Capital Losses?
In a perfect world, you’d have made WAY more in trades than losses, but we all know the world is not perfect and we will suffer losses at some point in the crypto space, if for no other reason than a pump and dump or a dipping market (which is out of our hands). However, if your losses exceed your gains, those losses will be deducted from your taxable income for the year.
The part that’s not so fun is in USA you may only deduct up to $3,000 from your taxable income. Any capital losses in excess of $3,000 are carried forward, year after year, and applied to taxes in subsequent years until the balance reaches zero. If you did incur substantial losses in cryptocurrency trading, it would be wise to work with your CPA to make sure you are filing correctly. (So if you made losses greater than $3K any year, you can keep carrying it over, which can actually be helpful if you have a lot of other gains outside of the crypto space).
Since the crypto space is new and there are a lot of trader that have no background in finance or investing, it is wise to study up on all the aspects needed to know when filing taxes in crypto. You should always consider consulting a licensed tax professional to work out the particulars for your federal, state, and local tax rates and tax brackets. In the meantime, here’s some imperative guidance about how the capital gains tax law applies to crypto.
By the way, tokens such as those issued in ICO or STO’s have no tax liability. That’s because you can only exchange tokens for other cryptocurrencies. In other words, you only have to pay taxes on your crypto assets that can be converted directly to USD, like bitcoin or ethereum.
New Regulatory Changes Will be Happening as the Market Evolves (Look for Loopholes)
Beginning in January 2018, two important amendments were added to federal tax law that have made a huge impact on how cryptocurrency traders report their taxes.
The first amendment investors call the like-for-like loophole. Using this loophole, technically called a 1031 exchange, investors can swap one like-kind business or property asset for another without having to pay capital gains taxes on the asset swapped. 1031 exchanges are exceptions to the normal rule since the IRS treats most swaps as taxable sales. Because the IRS also says crypto is property not currency, many investors assumed 1031 Exchanges could apply to cryptocurrency.
But the massive tax bill signed by President Trump in December limits 1031 exchanges to real estate holdings exclusively. For crypto traders and investors, that means no more like-for-like loophole. All currency swaps are taxable.
The second amendment deals with the Cryptocurrency Tax Fairness Act. Introduced by Republican Rep. David Schweikert of Arizona, the Act would exempt all cryptocurrency transactions below $600 USD from IRS reporting requirements. But Congress’ 2017 tax bill, signed by President Trump, effectively kills the Cryptocurrency Tax Fairness Act. And that means that this year, all of your crypto sales, exchanges, and purchases are taxable, down to the smallest transaction.
Helpful Tips for How To Pay Cryptocurrency Taxes Correctly
Since the work is undeniably difficult to maintain, some traders are willing to “take the chance” to not do their taxes on crypto trades and hope for the best.
But IRS doesn’t forget when it comes to money... If the IRS audits you, being able to show that you made every effort to pay your taxes (and that you even know how to pay cryptocurrency taxes) will go a long way toward avoiding tax evasion charges. So, when you’re ready to sit down and do your work, here are some tips for how to pay cryptocurrency taxes without going insane.
Keep Track of All Cryptocurrency Transactions
First, starting right this second, begin keeping track of all your cryptocurrency transactions in U.S. dollars. Start looking up your previous ones. Track dates and amounts paid/received for every transaction. If you lost your cryptocurrency wallet private keys, computer, hardware or paper wallets or even lost money on a scam, keep this in mind.
See If Your Exchange or Wallet Will Help You Out
Always take advantage of customer support from the cryptocurrency exchanges you use (which is why I ALWAYS recommend to do your homework ahead of time and only use exchanges with proven track records). Or email your cold wallet company to see if they have any services. These may prove extremely help and save you many hours of backtracking. Some exchanges will even issue proper 1099-K forms. Coinbase sends 1099-K reports to customers with $20,000 in gains or more and at least 2,000 transactions.
Use a Cryptocurrency Tax Service
(See tools below)
Now You Know How to Pay Your Cryptocurrency Taxes
Paying taxes has never been easier… (lol, but seriously, with this guide it should help tremendously). So let’s move on to how to LEGALLY AVOID paying taxes on crypto trades.
FOUR WAYS TO LEGALLY AVOID PAYING TAXES ON CRYPTOCURRENCY!
There are 4 ways to stop paying tax on your cryptocurrency gains. If you’re tired of the IRS taking half your short term profits and 20% of your long term gains, here are 4 ways to pay zero tax on cryptocurrency gains without getting in trouble with the IRS.
Note that this article is focused on US citizens and US persons (residents and green card holders). The United States IRS has declared that cryptocurrency is an asset or property, but not a currency. Therefore gains on cryptocurrency is treated the same as profits from the sale of a stock, rental real estate, or any other passive investment.
If you want to avoid tax on your cryptocurrency profits, you must plan ahead. Here are 4 ways
to stop paying tax on your cryptocurrency gains and your capital gains.
Buy Cryptocurrency in your IRA (Such as Charles Schwab Account)
The easiest way to defer or eliminate tax on your cryptocurrency investments is to buy inside of an IRA, 401-k, defined benefit, or other retirement plan. If you buy cryptocurrency inside of a traditional IRA, you will defer tax on the gains until you begin to take distributions. If you buy within a ROTH, you pay zero tax on the capital gains earned in the account.
To buy cryptocurrency inside of a retirement account, you must move that account outside of the United States and into an offshore IRA LLC which can open an offshore bank account and wallet to make the investment.
You’ll be the manager of the IRA LLC and in control of the investments. You’ll be in total control of the account and the sole decision maker.
To get your IRA offshore, you first form the LLC in a zero tax country. Then you move your account from your current custodian (such as Fidelity) to one that allows for offshore investments (such as Midland IRA). Finally you open an international bank or brokerage account and transfer the cash from your retirement plan into that account.
From here, you write the checks or send the wires. You make the investments and can choose cryptocurrency. If you want to invest in foreign real estate, physical gold, or crypto, go for it. You can also use your IRA to get residency in countries like Nicaragua or Panama.
Because you are the investment manager of your retirement account, you must follow all the IRS rules. You can’t borrow from the account, can’t personally benefit from the investments, and must treat the IRA as a professional investment advisor would. That is, all decisions should be in the best interest of the account.
If you already have a sizable retirement account, then buying cryptocurrency in your IRA might make sense. If you’re young, and don’t have a large retirement account, and can’t quickly build a defined benefit plan, then consider the options below.
Fyi… total annual contributions to your Traditional and Roth IRAs combined cannot exceed: $5,500 (under age 50) $6,500 (age 50 or older).
Buy Cryptocurrency in your Life Insurance Policy
Another way to pay zero tax on cryptocurrency gains is to buy coins within an international life insurance policy. You can fund an Offshore Private Placement Life Insurance with any amount of money you wish and create the equivalent of a ROTH or Traditional IRA. There are no contribution limits or distribution requirements.
Most offshore private placement policies require a minimum investment of $1.5 or $2.5 million.
If you setup a private placement policy, hold it for a few years, and then close it down, you get tax deferral similar to a traditional IRA. That is, you’ll pay tax on the gains when you close out the policy.
If you hold the policy until your death, and pass the cryptocurrency to your heirs, you get tax free similar to a ROTH IRA. Because of the step up in basis, your heirs receive the coins at their price on the date of your passing and pay zero tax on the appreciation while they were held in your life insurance policy.
Buy Cryptocurrency as a Resident of Puerto Rico
If you’re not old enough to have a large retirement account, and don’t want to lock up a couple million dollars in a life insurance policy, then consider moving to the US territory of Puerto Rico. The Caribbean island of Puerto Rico has a tax deal you can’t refuse! (So do many other countries that are crypto safe havens!)
We US citizens are taxed on our worldwide income. No matter where we live, we must pay US tax on our capital gains, including gains from cryptocurrency. The only exception to this rule is found in the US territory of Puerto Rico.
Puerto Rico sourced income is excluded from US tax under IRC Section 933. Puerto Rico sourced income is any capital gain or business income earned by a resident of the territory that qualifies for Act 20 or Act 22. A resident of the territory is any US citizen who spends at least 183 days a year on the island.
Because the territory is excluded from Federal taxation, Puerto Rico is free to make its own tax laws for residents an offer any type of tax breaks it deems appropriate. And in 2012, with amendments in 2015 and 2017, this is exactly what they did. It’s the amendments in 2017 that really made Puerto Rico the top offshore jurisdiction.
If you set up an online business in Puerto Rico, and qualify under Act 20, your Puerto Rico sourced profits will be taxed at only 4%. Distributions or dividends from this company to a resident of Puerto Rico will be tax free.
If you move to the island, spend 183 days a year there, buy a home within 2 years of moving, and otherwise qualify for Act 22, you’ll pay zero tax on long and short term capital gains. This means that trading profits from cryptocurrency are tax free to qualifying residents of Puerto Rico!
Finally, Puerto Rico is a popular jurisdiction for setting up a large cryptocurrency trading platform or an offshore bank. Act 273 allows you to build an investment management firm and pay only 4% in tax on your corporate profits. Act 273 is basically Act 20 for offshore banks.
Give up your US Citizenship
The most dramatic way to stop paying the IRS for your cryptocurrency gains is to give up your US citizenship. Once you expatriate, the IRS no longer has any right to your earnings.
US citizens pay US tax on their capital gains and cryptocurrency gains no matter where they live. If you move to Panama, but keep your US passport, you still pay US tax on your trading profits. The only way to get rid of the IRS forever is to turn in your blue passport.
To give up your US citizenship, you may need to pay an exit tax and must have a second passport in hand before turning in your US travel document. Without a second passport, there’s no way to expatriate from the United States.
You have two choices when it comes to getting a second passport. You can buy one from countries like Malta ($1.2 million), Dominica ($120,000) or St. Lucia ($500,000 investment), or you can earn one over time by becoming a resident of a foreign country.
For example, you can become a resident of Panama with an investment of $20,000. After 5 years of residency, you can apply for citizenship and a second passport. So, you can either buy a passport or earn one through residency.
Crypto Taxes Tools
Here is the ONLY cryptocurrency taxes account tracking tools that I currently recommend! My clients have used them and I have used Coin Tracking personally.
The benefit of these tools is they sync to various main exchanges and sync up all your trades an does the math for you which is ABSOLUTELY NECESSARY when saving time and money in the crypto space. And it’s nice and neat for your tax accountants (and the IRS if it comes to that…). Just always watch your back, especially when it comes to money.
Just in case you don’t like this one, here is a second option for you below (I have not used it yet but they have a great interface).
Hope this helps! Feel free to comment in the bar below if you have questions or found this to be informative and/or helpful.
Of course, not gonna leave ya hangin’! I’m going to offer you a way to get COMPLETELY EDUCATED in the entire crypto investing space by:
A) Taking my online course (then joining us in our VIP Telegram Channel afterwards)
B) Get privately trained with me on a personal basis or within our Inner Circle of the top minds in the crypto space for the most private information you can get anywhere!
All you gotta do is email me at CryptoKyle@KyleRea.net and let’s set you up for life.
Here’s some other free crypto resources btw…
Comment below if you have any questions, feedback, or you liked this blog. Safe investing!