When cryptocurrency investors complete the IRS Form 1040 Schedule 1 this year they will now have to answer a new question: “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
This new question on 1040 Schedule 1 is an advancement in the global trend for increased cryptocurrency tax enforcement. All U.S. taxpayers will now be required to answer this simple yes-or-no question.
Many crypto traders were already reporting their trading history for tax purposes before October 2019, but for those who are new to crypto investments or those who have never reported their digital assets, there are a lot of important questions to be answered.
How is Cryptocurrency Taxed?
In the US cryptocurrency is taxed as property, not as currency. This means that you can’t be taxed just for having cryptocurrency. If you buy or are a gifted cryptocurrency and never touch it again, you have no tax liability. But the moment you sell or otherwise dispose of that cryptocurrency you have incurred a capital gain or loss, and that needs to be reported.
In the same way as stocks or real estate, capital gains and losses are determined by a cost basis. Cost basis is the amount of money in USD that you originally paid to acquire the asset. You use this cost basis data and subtract it from however much you received when you disposed of the cryptocurrency, also known as fair market value.
Also Read: How to pay Tax on Bitcoin
The new 2019 IRS guidance also provided further clarification that airdrops, forks, and mined coins are taxed as income, rather than as property.
There are three situations that are not considered a taxable event.
- Giving cryptocurrency to another person
- Transferring cryptocurrency between different exchanges or wallets
- Buying cryptocurrency with USD
Even though these are not taxable events, for 2019, taxpayers will still have to declare on 1040 if they gave or purchased cryptocurrency.
The Big Problem
All of these reporting requirements can be exponentially more complicated for crypto traders who are making thousands of trades a year between many different cryptocurrencies and fiat currencies. And the bad news is that trading platforms like Coinbase are not able to provide accurate tax information if you have traded outside of their platform.
For example, if you buy cryptocurrency on Coinbase and then transfer to Kraken and then sell your cryptocurrency for US dollars, Coinbase is not able to track your assets once you transfer them to a different exchange. Coinbase can give you the cost basis of any cryptocurrencies you purchased on their exchange, but they cannot give you the cost basis of cryptocurrencies that you purchased on a different exchange.
Believe it or not, this is a feature not a bug of cryptocurrency exchanges. Each exchange platform is a separate silo that allows ordinary people access to the advantages of blockchain technology without having to interact with the blockchain directly.
What is needed is software that can extract trading information from each exchange, and then organize that information so that capital gains and losses can be tracked across multiple exchanges and currencies.
Your Accountant’s New Best Friend (or Worst Enemy)
This is where tax software tools are the best answer for tracking cryptocurrencies trades across multiple platforms. The nature of blockchain technology is such that all your trading data is safely stored and easy to access. The challenge is automating the process of putting all the data from different exchanges together in a way that makes capital gains and losses apparent.
Crypto tax software like CryptoTrader.Tax is uniquely equipped to collect trading data from all the major platforms and generate a tax report for 8949 and 1040. For traders who have years of historical trading data to sift through, tax software might be the only realistic answer to help them avoid trouble with the IRS.
Now that the IRS has put virtual currencies front and centre on the new 1040 many accountants across the US will be facing this problem for the first time. Either they will use cryptocurrency tax software or they will be replaced by cryptocurrency tax software.
The new cryptocurrency tax guidance is actually an advantage for crypto traders in the long run. Clear tax guidelines are part of the infrastructure needed to pave the way for cryptocurrencies and blockchain technology to realize their full potential as they go mainstream.
Not only that, but cryptocurrencies are uniquely positioned to help investors maximize tax-loss harvesting. With advantages provided by cryptocurrency tax software, crypto investors don’t have anything to worry about when they mark “Yes” on the new crypto IRS 1040 Schedule 1.