The tax season has arrived, and crypto investors taking part in the 2021 wild ride are likely to start thinking about what that means for their portfolios.
As with other investments like stocks, if you bought a digital asset and stuck to it, you do not have to do anything, said Charles Kolstad, a partner at law firm Whiters, which focuses on cryptocurrencies and blockchains.
But once you process a transaction, it immediately becomes a taxable event. This includes, among other things, selling your crypto, exchanging it from one token to another, mining the crypto and earning interest on your asset.
And while the Internal Revenue Service has published a thorough list of 46 frequently asked questions on its website, the agency still lacks a detailed list of crypto transactions, said Olya Veramchuk, director of tax solutions at Lukka, a provider of crypto asset data and software. .
“The current cryptocurrency guidance is so limited that it is always best for taxpayers to understand exactly what type of transactions they have been involved in and then try to analogize them to the existing framework,” Veramchuk told Insider.
She explained that different types of transactions generate different types of taxes. For example, selling a cryptoactive can trigger
tax, while more advanced activities from staking to dividend farming can provide tax on ordinary income.
Then there are winnings from certain transactions that do not nicely fall into any particular category, such as wrapping tokens, contributing to and paying out from
pools that, among other things, build bridges between multichain assets, which she described in a blog post. This is why Veramchuk advises taxpayers to consult experts if they are unsure.
The IRS first issued its guidance on virtual currencies in 2014, indicating that these should be treated as assets – not currencies – for federal income tax purposes. Yet it was not until 2019, when the agency asked about crypto in a Schedule 1 form and only in 2020, when they placed the issue prominently in Form 1040, the documents U.S. taxpayers use to file their annual tax returns.
Kolstad said he is often asked if the IRS sticks to these so-called “tax gaps” or the difference between what a taxpayer pays and what they owe. IRS Commissioner Charles Rettig estimated in April 2021 that the annual tax gap could exceed $ 1 trillion.
“What I’m telling them is that the IRS may be slow, but they are not stupid,” Kolstad told Insider, referring to clients who ask him about the agency’s perception of such gaps. “That was why they put it up on the front page so no one could say, ‘oh, I did not know that.'”
He divided three general types of income that crypto investors need to know:
- Ordinary income the return on activities such as staking and mining
- Short-term capital gains assets held for less than one year and taxed at ordinary income rates
- Long-term capital gains assets held for more than one year and taxed at reduced tax rates
Once you have identified your type of income, Veramchuk explained the different accounting methods you can use to calculate your capital gains or losses.
There is “highest in, first out” (HIFO) method, which allows the investor to sell the asset at the highest price they bought it, to reduce any capital gains. There is also “first in first out” (FIFO), as she said the IRS defaults, as well “last in, first out” (LIFO) method, which takes the purchase of the most recently purchased asset as the first to be expensed.
Taxpayers can use any method. What matters, she said, is the thoroughness of your record keeping.
“The crypto industry is eagerly awaiting guidance from the IRS and the Treasury because the crypto ecosystem is growing so fast,” Veramchuk said. “A lot of people would love to be as accurate as possible in their reporting, but we need a more detailed framework.”
In 2021, the total crypto
briefly topped a $ 3 trillion record, with bitcoin topping near $ 69,000 to its record high in November.
The tax season started on January 24 and ends on April 18 for most taxpayers.