Top 3 Misconceptions About Cryptocurrency & Taxes
Flipping into a new coin IS TAXABLE.
Trading into a new coin is NOT a like/kind exchange. The IRS has already specifically ruled that like/kind exchange does not apply to virtual currency transactions.
Losses from your crypto trading activity are extremely useful for offsetting your crypto gains, and lowering the total taxable amount. If you gain $50,000 in one crypto exchange and lose $30,000 in a different crypto exchange, then you only owe tax for the $20,000 in net gains. However, you can’t utilize this if you don’t actually report the trading loss.
The IRS can put you in jail for only two things - lying on a tax return and not filing a tax return. If you file a tax return and don’t report your crypto, you’re lying on that tax return.
It happens all the time. Someone has a tax question about how crypto trading affects their tax filing, so they turn to the internet for guidance.
Unfortunately, most information that’s readily available on this topic isn’t written by accountants or tax attorneys–it’s written by amateur crypto investors throwing out baseless, and downright dangerous advice.
The most recent example of this came to my attention earlier this week while browsing Reddit, where someone posted a specific question about their crypto/tax situation. After reading through hundreds of comments from people attempting to help, I was shocked to realize just how much bad advice is out there. And even worse is the fact that other people are believing it!
So it’s time to set the record straight: All of the advice that you’ve read online about crypto and taxes is wrong. If you’re willing to take this uninformed advice when filing your taxes this year, then you should be prepared to face the consequences.
FALSE: Flipping into a new coin is not taxable
Whenever you flip out of one coin and into a new one, that’s a reportable transaction that could expose you to tax. The OP in this Reddit thread was crushed that he had earned a bunch of profits flipping into new coin, had then lost most of his earnings in some market adjustments and now owed the IRS almost $50,000 in tax on transactions he never received goods or cash for. He said he’d talked to a tax lawyer, who suggested a payment plan.
Another example, I have a client - he’s an awesome guy, and he came in this year with his handful of W-2s and 1099s. Everything was going along and he said “I did some crypto trading, but I didn’t make any money. Well, I’m up, but I haven’t sold and taken anything out.”
Holy cow! Turns out he’d been flipping out of Bitcoin and into other coin, and was WAY up on all of the flips. Yikes! He about had a panic attack when I told him to get all of the information ASAP so we could start to avoid the bloodshed.
FALSE: Trading into new coin is a like/kind exchange.
Nearly every thread I read whether on Reddit or somewhere else has a bunch of posters who are convinced that their flipping up into higher values by trading coin for coin is a like/kind exchange.
The IRS has specifically ruled that is not the case. Even if it were true, every single flip would require a like/kind exchange report on form 8824. So, saying it’s not income because it’s a like/kind exchange without doing all of the paperwork is just a dodge without substance.
And, the IRS has specifically ruled that like/kind exchange does not apply to virtual currency transactions. So, every single transaction goes on form 8949, line by line, and ends up on Schedule D, capital gains and losses.
FALSE: Crypto gains are all that matter, and crypto losses are useless.
Most people think that their crypto gains are the only factor that matter, and that losses are useless. It’s true, there’s no way around getting taxed on the net gains. These threads share the notion of a bunch of traders that their gains are taxed but their losses are not.
If you’re trading crypto, you’ve most likely had some losses along with your gains. Your losses reduce your taxable gain. It all goes on form 8949. The net short term gain is taxable income and the net long term gain is taxable income. If you were up fifty thousand in one coin and down thirty thousand in another, your net gain is just twenty thousand. You pay tax on the twenty thousand.
So what can you do?
To claim the loss, you have to take the loss.
How many people do you know that have been complaining that their 401(k) has lost a bunch of value? Or that their stock has plummeted since first buying it? They didn’t actually have a loss–it’s just that if they sold right now, they would.
If you’ve taken a beating on a particular coin or in a particular exchange, and you haven’t yet liquidated that balance, you should talk to someone who understands these transactions and how they’re taxed about selling to get that loss into a form you can benefit by - one that will offset some gains that you don’t have the cash to pay tax on.
If you’ve had $50,000 in gains, but you’ve taken a beating in another exchange and you’re down $30,000 - you may be better off selling now, taking the $30k in losses and offsetting the gains to reduce your tax bill.
Stop taking tax and investment advice from anonymous strangers on the internet. Go talk to a professional, and do it right now. It’s going to cost you some money, but you’re going to come out ahead in every way: Lower tax bill, clearer understanding of what your actual income gains and losses are, and better understanding of what your investment costs are. Otherwise, you could be unintentionally hiding out from a huge tax obligation.
The IRS can put you in jail for only two things - lying on a tax return and not filing a tax return. If you file a tax return and don’t report your crypto, then you’re effectively lying on that tax return in the eyes of the IRS. Take a gander at the statement that you’re signing when you send in your return:
“Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct and accurately list all amounts and sources of income I received during the tax year.”
If you’re in the habit of believing everything you read from strangers on the internet, then I have a Nigerian prince you should meet.