You’ve made it to Part III of our three-part cryptocurrency series! As mentioned previously, we have put together this series to help taxpayers navigate through the tax laws of this ever-growing industry. Each article has covered one of three vital topics:
- Part I: Cryptocurrency reporting requirements
- Part II: Taxation of cryptocurrency
- Part III: Maintaining cryptocurrency records
The first two parts of this series covered the basics of when and where you need to report your transactions in cryptocurrency and how they will be taxed by the US government. If you have not read either of these two parts, it is recommended that you go back and catch up with Part I and Part II. Now, to wrap things up, the final part of this series will go into detail about the cryptocurrency records that you must maintain. As you preserve good records of your cryptocurrency transactions, you will find that you may also be able to decrease your final tax bill.
As noted throughout this series, there is one caveat. New rules and regulations are being proposed and written all the time (especially concerning this field), so while what we have discussed in this series may be true today, new laws and notices may make waves in this industry tomorrow. If you involve yourself in cryptocurrency, we highly recommend that you keep up to date on regulations to keep compliant.
Now let’s finish this series up!
The Importance of Maintaining Records
Remember back in Part I how we went through a hypothetical transaction where you sent cryptocurrency from a non-broker account, such as a wallet, to a broker or exchange? When you do this, the broker that receives the cryptocurrency has no idea of when the asset was purchased nor what the cost of it was.
When you go to sell that asset in the exchange, your exchange’s records will probably show the date it received the cryptocurrency from your non-broker account as the purchase date and a cost basis of $0. In order to determine the proper tax treatment, you must maintain records outside of that exchange showing your original purchase date and basis in the cryptocurrency.
Records You Should Keep Regarding Cryptocurrency
As mentioned in Part II of this series, many cryptocurrency transactions may receive preferential tax treatment. Most transactions where you sell, exchange, or otherwise dispose of cryptocurrency are considered capital gains transactions that may be subject to favored capital gains tax treatment.
When boiled down, there are generally five separate pieces of information that you should maintain when you dispose of cryptocurrency. They are:
This is the price at which you agree to sell your cryptocurrency. Keep in mind that even if a cryptocurrency is trading at a certain value at the time of sale, the actual return may be different due to fees, delays in the sales transaction, or other issue. Simply looking up the time stamp on a cryptocurrency tracking chart may give you an incorrect amount. Either way, you must know what the actual sales price is.
The date on which your asset is disposed of. Some exchanges may have delays between when you place an order and when they purchase the cryptocurrency, so the date of sale may be different than the date requested.
Fees are typically charged for many cryptocurrency transactions and may be significant. You may subtract any fees or other sales-related expenses from your sales price on your tax return.
The basis of your cryptocurrency is the original purchase price plus any acquisition-related expenses. Just like when you sell cryptocurrency, exchanges and other account holders often charge fees upon purchase. The IRS allows you to add these expenses to your basis. When filing your tax return, you may subtract your basis in the cryptocurrency sold from the sales price.
The date on which your asset was purchased. Without this record, the IRS will not know how long you held the asset and may disallow preferential capital gains tax rates, even if you know you held the disposed cryptocurrency for longer than one year.
It is imperative that each taxpayer maintains all five of these records so that they can receive the best tax treatment possible. When determining the final, taxable total upon the sale, the taxpayer uses the following formula:
Where to Obtain Records Regarding Basis and Original Purchase Price
Without good recordkeeping, you may find yourself paying more tax than needed. For example, say you purchased one Bitcoin five years ago. You then start slowly selling it off in increment amounts through the years. You must be able to know what the original purchase price was and then divide that cost into the portions sold each time to get an accurate basis. Without proper records, this would be a headache and potentially be impossible to determine the annual taxable amount.
Fortunately, as mentioned in Part I of this series, Congress recently passed a ruling requiring cryptocurrency brokers to issue a 1099-B showing vital information required for tax reporting of each sale during the year including sales price, the cost of cryptocurrency sold, and dates. As mentioned, there are some major issues that need to be addressed regarding this type of reporting, but it also may greatly facilitate the information gathering process for many taxpayers. However, cryptocurrency brokers are not required to issue these records until their 2023 reports, so in the meantime, taxpayers must come up with a different way to maintain documentation.
Most cryptocurrency exchanges will provide spreadsheets or other documents showing much of the required data. However, these records may not be well organized and may be hard to read. It is up to the taxpayer (or they may pay their accountant to do so) to do much of the legwork to determine the correct tax treatment of sales. In a worst-case scenario, the taxpayer may have an account that does not maintain adequate records at all. In this case, the taxpayer must track their basis outside of the account.
There are third-party sites available that will link to cryptocurrency broker and non-broker accounts alike and will track cryptocurrency information for you. These sites will generate detailed, organized forms for tax returns at year-end. These third-party vendors will almost always charge to track basis and provide forms, but their services may be very beneficial if you have many cryptocurrency transactions. If this is the direction you want to go, we suggest you do your research and find a reputable company that will generate a legible report at an agreeable price.
Record Keeping for Miners
Record keeping is not just important for people buying and selling cryptocurrency, it also important for crypto miners as well. If you are a miner and can classify your mining activities as business-related activities, you will be able to offset your revenue with expenses you incurred over the course of generating income. This can be significant because mining can get very expensive.
If audited, you will need to be able to provide meticulous documentation detailing your business expenses. If you are unsure if your mining activities qualify as a business or what qualifies as business-related expenses, consult your tax preparer, and they will be able to assist you.
What if I Received Cryptocurrency as a Gift?
Just as you may receive $20 for your birthday, cryptocurrency can also be given as a gift. See Part II of this series for the tax ramifications of gifts.
When you obtain cryptocurrency, your wallet or exchange will show the market value at the time of receipt as the cost of the cryptocurrency obtained. Typically, this would be your basis in the cryptocurrency. However, if this cryptocurrency was a gift to you by someone else, the donor’s basis is transferred to you and will become your basis. Additionally, the holding period of the donor will become your holding period.
Most of us do not want to pay a dime more in taxes than required. Neither do you want to receive a notice from the IRS. In order to reduce your final tax bill, you need to maintain good records detailing your taxable activities. This is good advice to follow with all income and deductions on your tax return, but especially with your cryptocurrency transactions.
Hopefully, this series has given you some insights that you may have been previously unaware of into the cryptocurrency tax world. We have gone through cryptocurrency reporting requirements, taxation, and record keeping. With further knowledge of these subjects, you should be able to have a better idea of what transactions you need to report on your tax return and what information you must provide to your tax preparer.
If you have any questions regarding cryptocurrency record keeping, or any other tax-related cryptocurrency topics, please contact us and we will be happy to assist you.
Written by: Ben Noel, CPA – Senior