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Tax Planning for Cryptocurrency

7 minute read

Cryptocurrencies have been gaining traction over the past decade, and in more recent years have begun to hit the mainstream. In most jurisdictions around the world, including the US, UK and Canada, cryptocurrency transactions are taxed to some degree. Here is what you need to know about tax planning for cryptocurrency as they grow in tax practice:

Grow a Tax Practice Doing Tax Planning for Cryptocurrency

In the United States, cryptocurrencies are treated as property. This means that if the asset, such as Bitcoin, appreciates in value and your client sells or trades it, there will be capital gains tax. Likewise, if the cryptocurrency depreciates in value and your client sells or trades it at a loss, they may be able to deduct the losses against other capital gains to reduce their taxes.

For many cryptocurrency investors, this can get complicated fast due to the fact that the amount of tax can vary depending on multiple factors, such as how long the asset has been held, the cost basis, the sale value, and any fees associated with the transaction. Many cryptocurrency enthusiasts also make multiple trades, sometimes daily, and keeping track of each of those taxable events created can quickly become a job in and of itself.

Taxes Triggered by Cryptocurrency

Here are the main taxable events you should be aware of:

  • Trading a crypto for another crypto, such as Bitcoin traded into Ethereum
  • Using crypto such as Bitcoin to buy a good or service
  • Selling any crypto for any fiat currency
  • Receiving crypto as a result of a blockchain “fork” or from mining it

The IRS has plainly stated that like-kind exchanges are not allowed so every cryptocurrency-to-cryptocurrency exchange is a taxable event.  

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Taxes Not Triggered by Cryptocurrency

Some events are not taxable:

  • Donating cryptocurrency to a tax-exempt organization
  • Transferring cryptocurrency from one wallet you own (either digital or hardware such as a Ledger) to another wallet you own
  • Gifting cryptocurrency to someone (but it can be taxable if it’s large enough to trigger a gift tax)
  • Buying cryptocurrency with fiat currency

Assuming FIFO, here is a sample of what cryptocurrency taxes could look like in a hypothetical scenario:

  1. Kevin buys 2 Bitcoin at $10,000 each, no taxes owed.
  2. Kevin receives another Bitcoin as a gift, no taxes owed.
  3. Bitcoin price increases to $20,000 in price, so Kevin’s total holdings increase to $30,000 but he doesn’t sell, no taxes owed.
  4. Bitcoin goes back down to $15,000 and Kevin trades 1 Bitcoin to Ethereum. This is a +$5,000 capital gain, regardless of what the price of Ethereum does in the future. 
  5. Kevin transfers some of his Bitcoin to a second wallet of his, no taxes owed. 
  6. Bitcoin forks and produces “Bitcoin Lite”, which is valued at $2,000. This is taxable because it’s considered +$2,000 of income.

These are just some of the scenarios to watch out for when tax planning if you hold cryptocurrency. 

Properly Filing Cryptocurrency Tax Returns

Since the first guidance the IRS offered in 2014 under Notice 2014-21, they have created a variety of tax forms which may apply for crypto tax filing depending on your filing as an individual or for a business. Here are some key forms to pay attention to when preparing a return:

Form 8949—Sales and Other Dispositions of Capital Assets: this is a complete list of every cryptocurrency disposal your client has had (e.g. sell, trade, etc.)

Schedule D—Capital Gains and Losses: this is an aggregate sum of your client’s capital gains across all asset classes

Form 1040—Individual Income Tax Return: including your Schedule D information

Schedule 1—New in 2019: This is the first question about cryptocurrency plus any income (from forks, airdrops, mining, or payments) that goes on the “other income” line 21

How Tax Planning for Cryptocurrency is Evolving

As cryptocurrency continues to become more mainstream, the IRS will likely continue to update its guidance as this new blockchain technology evolves over the coming years. Bitcoin and other digital currencies are now available on popular apps like Robinhood. Even PayPal announced that its customers will be able to buy and sell cryptocurrency using their PayPal accounts.

Since cryptocurrency is in such high demand, it's important to tax plan if you already own cryptocurrency or if you plan to acquire some in the future: there is already a large market for tax planning. Considering that cryptocurrency exchange Coinbase has already been in contact with the IRS and an estimated 11% of Americans already hold Bitcoin.

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