The cryptocurrency world was confusing enough before the U.S. Internal Revenue Service got involved and cryptocurrency tax was born. In late 2017, the IRS ruled that the like-kind loophole popular with real estate investors did not apply to cryptocurrencies, so taxes were owed on all trades.

This caught many folks off-guard. Luckily, we’ve compiled 11 common crypto tax pitfalls for you to avoid in the upcoming year. This list should give you some good guideposts to steer between when making your cryptocurrency trades so that you don’t end up owing the IRS unexpected sums at the end of the year.

Not Keeping Track of Your Trades

Many new crypto traders assumed – incorrectly – that taxes would only be due when they ultimately cashed out, or converted their crypto holdings into fiat, like U.S. dollars. That just isn’t so. All crypto-to-crypto trades are taxable events, so it pays to keep track of everyone.

This can be a tedious exercise if you’re using pen and paper or a spreadsheet program, but many exchanges allow you to export a trade history for tax purposes. Still, in the unlikely event your exchange goes down or discontinues this program, it’s a smart idea to have a backup of your trades available.

Not Understanding Cost Basis

This trips up more crypto traders than you’d think. Taxes are owed on the difference between the crypto’s original value and the gain or loss incurred after. This is referred to as your cost basis. For example, let’s say you got in the game early and bought a new coin for $10. By the time you decide to sell it, that coin has risen in value to $30. The $10 figure is your cost basis.

To calculate how much tax you owe, you subtract the sale value from your cost basis, meaning you owe a percentage of the $20 profit you collected. That percentage you owe will vary based on several factors, including your tax bracket and how long you held the coin for – more on that later.

Not Setting Tax Money Aside

One big pitfall many traders made in 2017 was trading all they had with every transaction. That is, they’d profit from the trade of one coin and immediately sink all their profits into another deal. This system works great if prices continue to rise. However, because you owe taxes on every trade, if you use all your profits in subsequent trades and the price goes down, you might end up owing more to the IRS than you have.

Let’s go back to that $20 profit you made on your original $10 coin. If you took that $20, sunk into another coin, and that coin’s price flopped, you now have no money in the market. You still owe taxes on the $20 gain, however. You can claim a loss, but the IRS sets hard limits on how much of a loss you are able to claim. It’s far safer to set money aside and cover yourself in the event of a sudden loss.

Cashing Out Too Soon

Since cryptocurrencies are taxed via the capital gains system, there are two different rates you could potentially pay. Short-term capital gains are gains realized within 12 months, and they tend to be very high – as much as 40 percent, depending on your tax bracket. Long-term capital gains are much lower, and they kick in when you’ve held an asset for more than 12 months.

If you like to day trade and move coins around frequently, you could be racking up a substantial short-term capital gains tax liability. Try to pick coins that you feel comfortable holding for more than 12 months to limit this exposure, or only make trades when you feel the potential 40 percent tax penalty is worth the overall profit.

Another strategy popular in the cryptocurrency arena is called HODL, or “hold on for dear life.” Buying a cryptocurrency with fiat currency is not a taxable event. In other words, you would never owe taxes on $10 in Bitcoin that you bought and never did anything with.

HODL revolves around buying coins that you don’t expect to touch for a long time – years, in most cases – and waiting for them to gain in value. You will ultimately pay taxes when you decide to cash out, but the thinking is that the coins will be worth more than enough to cover your tax liability and a hefty profit when you eventually decide to exit the market.

Not Asking for Help

Tax professionals are just as new to the cryptocurrency game as everyone else. That said, a tax professional will have a much more complete understanding of the intricacies of U.S. tax law and will be able to guide you through the filing process. There are even a limited number of tax professionals that specialize in cryptocurrency.

They’re liable to be pricey, but probably significantly less pricey than finding out years down the road during an audit that you failed to pay hefty amounts of tax on your cryptocurrency gains. Don’t be afraid to seek professional help regarding your crypto tax liability. If you feel like your longtime accountant isn’t up to the job, consider a separate tax professional to look specifically at your crypto liability.

Cryptocurrency is confusing, and the tax laws surrounding it are even more so. Avoiding these five mistakes, however, can save you a lot of money come tax-time. It can also save you the hassle of an audit down the road should you throw up your hands and decide to try to dodge the crypto taxes you owe. That’s more common than you think.

The IRS estimates that only a tiny fraction of crypto owners actually pay the taxes they owe. It’s not worth the risk, however. The IRS has years to work through its backlog of crypto tax cheats, assigning penalties all the while. Don’t fall into that trap. Just follow these five simple guidelines and trade with peace of mind, knowing that you’ll be covered next April.

 

About the Author

Daren is a cryptocurrency investor, miner, and blockchain developer. He researches the latest trends and technology in decentralized products and services.

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