CRYPTO INTELLIGENCE SYSTEMTM
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Tax & Tracking
How to Prevent Crypto Tax Mistakes (& Avoid Paying Crypto Taxes)
Avoid costly crypto tax mistakes and unnecessary taxes
To prevent crypto tax mistakes and avoid overpaying taxes on crypto, you have to figure out what you owe and when you owe it. Calculating cryptocurrency tax liability and understanding when to pay the tax are both an art form. Incurring a tax liability and making payments are two separate things and they can be a game of timing inside and outside of crypto.Â
Here is a step-by-step approach to reporting crypto taxes, from tracking transactions to filling out necessary forms as well as common mistakes to avoid and tips on maintaining accuracy and compliance.
1. Record all transactions
Start by maintaining a detailed record of all your cryptocurrency transactions. This includes purchases, sales, exchanges, and any other activity involving digital assets. Accurate record-keeping is the foundation of proper tax reporting. Create an inventory tracker of all the exchanges and wallets you used and blockchains you interacted with. This may seem trivial for a newbie, but it’s easy to cast a wide net in the crypto ecosystem over time so start by using a master list because it will pay dividends. Save all exchange and wallet downloads as raw CSV files even if tax software allows automatic importing with APIs.
2. Categorize transactions
Classify each transaction correctly. Identify whether it is a purchase, sale, exchange, or any other taxable event. Crypto tax software is not a magic wand so all transactions should be reviewed for accuracy and completeness to make sure they are coded the right way.
Key Takeaway
There are always issues cryptocurrency tax issues to fix within tax software related to categorization (e.g., airdrop, transfer). If you don’t carefully review your transactions, you may make mistakes and overpay taxes.
3. Calculate gains and losses
Determine the gains or losses associated with each transaction. This involves calculating the difference between the acquisition cost and the selling price. Crypto tax software is necessary to calculate gains and losses. Make sure you choose an acceptable cost basis method for your jurisdiction. Different cost basis methods produce different gains and losses, you may be able to choose a method that lowers your taxes over time. Unfortunately, it’s very difficult to know which cost basis method is best for your future investing activities. Â
4. Identify taxable events
Recognize taxable events as mentioned under specific cryptocurrency activities such as purchasing goods and services with crypto. These end up being the transactions people can’t remember months later when doing their taxes. Add events like airdrops and buying stuff with crypto to your inventory tracker. It’s these “one off” events other than trading crypto where tracking will pay dividends when reviewing transactions in tax software.
5. Determine holding period
Differentiate between short-term and long-term holdings, as tax rates often vary based on the duration of ownership. Some jurisdictions may offer preferential tax rates for long-term capital gains. Crypto tax software will handle long-term and short-term gains; however, you can’t change the holding period after the fact. Therefore, use the dashboard within crypto tax software or another portfolio tracker to be aware whether a trade is a long or short-term trade. You could double your tax if you are not paying attention.Â
6. Choose a reporting method
Select a reporting method for calculating gains and losses. Common methods include First-In-First-Out (FIFO),Last-In-First-Out (LIFO), Closest-Cost-First-Out (CCFO) or some variation that optimizes paying the lowest amount of tax (when allowed in your jurisdiction). Every crypto tax software option has a FIFO option, but the question is what other methods are available. Compare your FIFO gains and losses calculation with another method by going to the settings, clicking another method and then recalculate. Consistency in the chosen method is essential for accurate reporting.
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Key Takeaway
Once you choose a cost basis method, you have to stick with it for all subsequent years. You can’t change your cost basis from year to year to use the one that produces the lowest tax. If you do this, you’ll be double counting and/or omitting your crypto which means you will overpay or underpay your taxes. Both of these are a problem.
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7. Use crypto tax software
Use specialized crypto tax software to streamline the reporting process. These tools can automate calculations, track transactions, and generate tax reports. As stated, crypto tax software is NOT a magic wand and it’s not as simple as linking exchange accounts and clicking calculate. At the same time calculating taxes on crypto gains is nearly impossible without using software. This is why using an inventory tracker and having complete and accurate records is critical to the outcome of your taxes. Crypto tax software is your friend but all software has technical limitations so some software will be better than others based on your use case.Â
8. Complete tax forms
Fill out the necessary tax forms specific to your jurisdiction. In the United States, for example, Form 8949 and Schedule D are commonly used for reporting capital gains and losses. Form 8949 or any other form produced by the crypto tax software can be used by any CPA, CA or other tax professional without any knowledge of crypto because they already know how to deal with those forms. The summary numbers are included in the tax return software and the form is attached. A CSV file of crypto gains and losses can generally be used in lieu of a tax form if it’s formatted the same way. Sometimes the software produces errors than can’t be fixed with a manual override so the CSV method is the only way to fix the presentation.
Related: How to Navigate Taxes on Cryptocurrencies
Tax professionals take note
Tax professionals on the other hand should consider whether they have the expertise and the liability for preparing tax returns where the client completed the crypto tax calculation. If those calculations and the related forms are incorrect as supplied by the client, then tax pros could be on the hook for various issues. Tax pros should have a due diligence check list and someone with deep knowledge and expertise in crypto before taking on any crypto tax clients.
Common crypto tax mistakes to avoid
Common crypto tax mistakes to avoid include failing to report all transactions, misclassifying them, and disregarding taxable events. Accurate record-keeping, proper classification, and staying informed about tax regulations are essential to sidestep these pitfalls and ensure compliance where every regulator in the world has increased scrutiny for taxpayers engaged with crypto.
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Failure to report all transactions
One of the most common mistakes is omitting transactions from the report. Ensure that every buy, sell, and exchange is accounted for to avoid discrepancies. This goes back once again to using an inventory lead sheet to track all exchanges, wallets, blockchains etc. because it’s very easy to create new wallets, accounts, addresses and then lose track of them.
The Crypto Tax Blueprint course includes a Lead Sheet Inventory Matrix that’s worth the price of the course.
Key Takeaway
Missing transactions whether intentional or not can result in incorrect calculations and overpaying tax in the current and future years. Every transaction from the beginning of time (your first crypto transaction) must be included since taxes on crypto gains in the current year are calculated based on all transactions back to the beginning.
Misclassification of transactions and ignoring taxable events
Misclassifying transactions can also lead to inaccurate tax calculations. For example, Alice used ETH to buy a meme coin from a pre-sale event, but later confused it for computer equipment from Tiger Direct. She didn’t keep accurate records and a mistake like this can cascade into a series of inaccuracies. In addition, an airdrop may get picked up by crypto tax software as zero income because of the timing and the price feed used by the software. This may or may not be accurate and requires expertise to consider these types of issues.Â
Identifying transfers between wallets
Transfers are non-taxable events. Just like bank transfers moving funds from one account to another a crypto transfer is simply moving funds from one place to another. Keep in mind this applies to the accounts of the same owner so when Bob transfers Bitcoin from Kraken to his Trezor for cold storage, it’s a transfer. If Bob, transfers Bitcoin from Kraken to his friend Alice it’s not a transfer but rather a gift or possibly an expense. People sometimes use the word “transfer” loosely; however, it has a specific definition in the context of taxes.
Avoid pitfalls, eliminate headaches, and produce useful financial data. Never overpay or under report your taxes.
Get the Crypto Tax Blueprint CourseHow to avoid common crypto tax mistakes
Crypto tax mistakes can be costly, so one of the best ways to be successful in crypto is to avoid expensive mistakes and audit-proof your tax return.Â
Stay informed
Regularly update yourself on changes in tax regulations and reporting requirements. Being aware of any updates can help you avoid common pitfalls. Check out books like The Crypto Tax Blueprint™ How to Avoid Expensive Mistakes and Audit-Proof Your Tax Return.
Consult a tax professional
Seek advice from a tax professional or accountant experienced in cryptocurrency taxation. They can provide guidance based on your specific situation, but they are in high demand and low supply. Taxpayers are relegated to doing 50% or more of crypto tax management even if they want to outsource tax prep to a professional. You control your own assets (i.e., exchanges and wallets); therefore, you control all the transactions. It’s always a good idea to get professional advice even if you prepare your own taxes.Â
Regularly review and reconcile
Periodically review your transaction history and reconcile it with your records. This proactive approach helps identify and rectify errors promptly. The longer you wait to review transactions, the more time it will take to sort out and the more mistakes you’re likely to make. Some exchange data becomes unavailable after a certain amount of time so waiting too long could result in missing transactions.Â
Keep detailed records
Maintain organized and detailed records of all your cryptocurrency activities. Accurate record-keeping is your best defense against potential reporting mistakes. Download and archive all exchange reports and wallet activity in raw format and “save as” to a new file for any import formatting. Use your inventory tracker to document when you downloaded the information. Take screenshots of airdrops, rewards, staking or any other crypto events other than trading to create your own reference material. Sometimes if you don’t capture it in the moment, you can’t get the information at a later time.
Key Takeaway
Assume you will have to troubleshoot your crypto tax software and transactions. Troubleshooting approaches the impossible if you don’t have data to reference which is why you should take screenshots and make memos along the way.
Taxes on crypto gains
Calculating and reporting crypto gains is a crucial aspect of managing your financial responsibilities as a cryptocurrency investor. Understanding the methodologies to compute gains and employing legal strategies to minimize tax liability is essential for optimizing your overall tax position.Â
Calculating crypto gains
To calculate crypto gains, subtract the acquisition cost from the selling price. This is essentially the same for any asset in most jurisdictions. The concept is simple, but in practice the calculations can be challenging depending on the complexity of your crypto transactional landscape. Crypto tax software will do most of the heavy lifting, but it’s also not a magic wand as stated before. In addition, if your crypto activity is limited to trading only you’ll be on the more simple side of calculating crypto gains. Â
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How to avoid paying taxes on cryptocurrency
Tax planning strategies for crypto investors involve strategic timing of transactions and tax-loss harvesting. Investors can employ a "HODL" strategy, holding onto assets for a longer time to qualify for lower long-term capital gains tax rates. Timing the sale of assets is one of the most important tax strategies for taking both gains and losses. Â
Here’s a closer look at how to avoid paying taxes on crypto:Â
Tax-loss harvesting
Tax-loss harvesting involves strategically selling assets that have unrealized losses to offset gains in other investments. Unrealized losses are only potential benefits so knowing your tax positions in crypto is super important. You have to turn an unrealized loss into a taxable loss by selling your crypto. One of the worst tax mistakes is not taking losses on a bad investment that could have offset gains.
In the U.S., for example, capital losses are limited to $3,000 per year and can’t be carried back, limiting the benefits of excess losses. The good news is those excess losses can be carried forward to offset gains in future years. If you have a carry forward loss of $75,000, then taking profits in a future year is more enticing because there is no tax on at least $75,000 of fresh gains.Â
Holding strategies
The duration for holding your cryptocurrencies can impact tax rates. Long-term capital gains are the holy grail among tax types in many jurisdictions because of the low tax rates. In the US long-term tax rates could vary between 0% to about 41% (also considering the net investment tax) depending on tax bracket and other sources of income. The timing of gains is one of the biggest wild cards in tax planning. . You also can’t think about tax just on gains, but rather your entire tax situation and all other buckets of income.
Use of tax-advantaged accounts
Depending on your jurisdiction, utilizing tax-advantaged accounts such as Individual Retirement Accounts (IRAs) or similar vehicles can provide a tax-efficient way to invest in cryptocurrencies. A self-directed SEP IRA set up with a business is a slam dunk for tax benefits, If the sole owner of an S-Corporation has a $200,000 salary, they can deduct a $50,000 profit-sharing expense from a business and invest the $50,000 in Bitcoin tax-free.  You end up with a simultaneous deductible expense and a tax-free investment at the same time.Â
Gifts and donations
Some jurisdictions offer tax benefits for charitable contributions. Consider donating appreciated cryptocurrencies to eligible charitable organizations. This not only supports a cause you believe in but may also provide a deduction on your taxable income.
Addressing cryptocurrency tax issues
Navigating the complexities of cryptocurrency taxation brings forth a myriad of challenges for investors. From ambiguous regulatory guidance to valuation dilemmas and the taxation of emerging phenomena like decentralized finance, forks and airdrops, addressing these common crypto tax issues requires a proactive approach by the taxpayer even when using a tax professional.Â
To address these issues, it's critical to stay informed about evolving regulations, leverage tax software for accurate record-keeping, and consult with crypto tax professionals for personalized guidance. Get great resources like The Crypto Tax Blueprint™ How to Avoid Expensive Mistakes and Audit-Proof Your Tax Return. Don’t make crypto tax an end of year exercise and instead invest, track, and repeat. Otherwise, you’ll get tax rekt.
Key Takeaway
Crypto is a team sport and a participation sport especially when it comes to taxes. The benefits of crypto and blockchain technology have huge upside potential so the more the more effort you put into it the more you get out of it. The challenges of cryptocurrency tax issues are part of the game and should not stop you from investing.
As you play in the crypto space, it’s critical to stay informed about crypto tax regulations and stay compliant in order to experience a successful and sustainable crypto investment journey. Navigating taxes on cryptocurrencies may seem daunting, but with a solid understanding of the regulatory landscape and proactive tax planning, you can get a Crypto Bullseye™.
As always your goal is to get a Crypto Bullseye™.
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