Cryptocurrency investors had a wild ride over the past two years. From Dec. 20, 2020, to Dec. 19, 2021, bitcoin's (BTC) price rose 93% and ethereum (ETH) grew by 495%.
But the good times were over by November 2021. Bitcoin and ethereum both peaked early that month, and their collapse since then has been dramatic. From Dec. 19, 2021, to Dec. 18, 2022, bitcoin dropped 67%, and ethereum fell 70%.
Given that pattern and the coins' currently depressed market prices, it's likely that your clients who bought crypto over the past two years and are still holding their positions have unrealized losses in their portfolios. It's a good time to review tax rules and strategies for crypto investors to learn what, if anything, can be gained from crypto's crash.
How the IRS Sees Crypto Gains and Losses
The IRS treats cryptocurrencies as property, so the same short-term gain and loss or long-term gain and loss rules apply to the sale of crypto assets that apply with other traditional capital assets, says Jesse Rodriguez, manager in Kaufman Rossin's tax advisory group in Miami.
"It's based off the holding period and the tax rate depends on the adjusted gross income of the taxpayer and their filing status," Rodriguez explains. "Short-term rates will be taxed at the ordinary income rates and the long-term rate can be 15% or 20%, depending on the total adjusted gross income for the specific year."
The additional 3.8% net investment income tax may also apply, he adds.
Charles Kolstad, partner in the private client, tax and corporate teams at international law firm Withers, adds a caveat for active traders, though. "In most cases, investors are not dealers or traders and thus report all gains and losses as either short term (held less than 12 months) or long term (held more than 12 months) capital gains or losses," he explains. "Investors who trade regularly may qualify as a trader, in which case the gains and losses constitute ordinary income or ordinary losses."
How to Report Crypto on Your Taxes
The tax forms for reporting crypto transactions should be familiar to securities investors. Trevor English, vice-president of marketing with Ledgible, a crypto tax and accounting platform, says that taxes on crypto transactions are generally reported on Form 1040 Schedule D and Form 8949, which is used to report sales and exchanges of capital assets.
Investors may also receive a Form 1099-B from the exchanges they use and, in the future, they might receive a Form 1099 specialized for digital assets, tentatively named Form 1099-DA, from the crypto exchanges where they trade.
Tax Complications
However, investing in crypto can increase filing complexity because the IRS is very focused on the potential for tax evasion through the use of crypto assets, according to Kolstad. For instance, he notes that on the first page of Form 1040, taxpayers must answer whether they have engaged in any crypto transactions for that taxable year. Specific transactions' taxation can be complicated, as well, Kolstad says.
"Crypto is classified as property for U.S. tax purposes, so each transaction involving the conversion of fiat currency, such as U.S. dollars, into crypto, the exchange of one form of crypto for another, the exchange of crypto for NFTs (non-fungible tokens), the sale of NFTs for crypto, and the conversion of crypto back to fiat currency are all separate taxable events," he explains. "Investors need to track their tax basis for U.S. tax purposes to determine their taxable income in U.S. dollars, not in crypto, so many investors are sitting with large, unrealized taxable losses."
Tracking tax basis and calculating gains and losses on crypto transactions can mean unexpected work for securities investors who are accustomed to receiving detailed Forms 1099-B from their securities brokerage firms, Rodriguez says. Some crypto exchanges may provide a Form 1099-B, but the report might lack cost basis information if the crypto holdings had been moved between an offline storage device (a "cold wallet") and the exchange account.
Also, crypto users often have accounts on multiple crypto exchanges and have multiple self-custodied wallets on which they store their crypto and NFT holdings, Kolstad says. Transfers from one wallet to another are not taxable events, but the tax basis in the transferred crypto must be tracked across multiple wallets. This can make determining the correct amount of taxable income difficult for investors who trade frequently.
That difficulty has spawned several crypto portfolio and tax reporting software applications that provide basis- and trade-tracking and portfolio reporting. These programs, such as Ledgible and CoinLedger, among others, allow tax investors to link their accounts with the exchanges they use and their crypto wallets; the integrated tracking and reporting helps with tax-return information.
"They do a pretty good job at summarizing the gains and losses, and we definitely work hand-in-hand with a lot of these platforms," Rodriguez says. "They're definitely a big part of the tax component."
Basis reporting could improve in the near future and make tracking simpler. According to Thomson Reuters and Ledgible, crypto reporting requirements under the November 2021 Infrastructure Investment and Jobs Act (PL 117-58) take effect on Jan. 1, 2023, and will affect the U.S. crypto industry. Key crypto-related provisions include:
- The Act extends reporting requirements for transactions involving over $10,000 in cash to transactions involving digital assets.
- The Act has the potential to affect what information businesses collect and report to the IRS in regard to crypto transactions. While 1099 reporting is coming to the digital asset space, more concrete regulation might be forthcoming from the Securities and Exchange Commission and IRS.
- The bill mandates that crypto exchanges send Form 1099-B to report a yearly profit or loss of a given crypto asset. The new rules will apply to statements issued after Dec. 31, 2023, so information returns issued in 2024 will cover 2023 transactions.
Spending, Earning, Mining and Staking
Some clients may have expanded their involvement with crypto beyond buying and selling. They might be making transactions with it, getting paid in it, mining it or earning interest on their holdings. Transactions initiated by exchanges, such as the colorfully named airdrops, hard forks and soft forks, can also have tax implications for investors.
