Cryptocurrency may be akin to digital money — but it’s a long way from cash for tax purposes. For example, digital assets are classified as property by the U.S. Internal Revenue Service (IRS).
Traders and investors everywhere are adding cryptocurrency to their portfolios. And at tax time, they may be going to their tax professionals for advice on how to handle these assets. Tax professionals increasingly are needing to ascend a steep learning curve to provide their clients with expert advice on cryptocurrency taxes.
However, cryptocurrency tax issues don’t have to be time consuming or scary — and tax professionals can provide exceptional value to clients by remembering some core principles and following established best practices.
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1. Treat cryptocurrency like property
As mentioned, the IRS classifies cryptocurrency and other digital assets as property. Standard property tax rules apply, with realized capital losses or gains typically determining crypto tax liability.
The treatment of cryptocurrency like property makes it akin to real estate or stock for tax purposes. Just like you would report capital gains or losses from any property transaction, the same is required for most transactions involving cryptocurrency.
2. Know what qualifies as a taxable event
Not all crypto transactions have tax implications. Using fiat money to buy and hold cryptocurrency is generally not taxable until the crypto is traded, spent, or sold.
Tax professionals can reduce their mental load by clearly understanding which types of crypto activities and transactions can have tax consequences, such as:
- Selling cryptocurrency — A client who sells cryptocurrency or digital assets for profit is required to report the capital gain. A client who loses money from a crypto sale can report a capital loss.
- Trading cryptocurrency — Using crypto to purchase more cryptocurrency or trade for other tokens is taxable. IRS taxation rules on short-term and long-term capital gains apply to crypto.
- Spending cryptocurrency — Clients who use cryptocurrency to make purchases are required to report any capital gains or losses. The net gain or loss is calculated at the time of the purchase.
- Earning cryptocurrency — A taxpayer who receives crypto for providing for goods or services is required to report that cryptocurrency as income. The market value of the cryptocurrency at the time that it is paid determines the client’s tax burden.
- Staking or mining digital assets — Receiving cryptocurrency from mining, staking, or another on-chain activity can create tax consequences. The trading price of the cryptocurrency at the time that it is generated generally determines the cost basis for tax purposes.
3. Understand how DeFi and ICOs are taxed
Questions like, How are new crypto tokens distributed for the first time? and What’s the role of decentralized finance (DeFi) in all this? are crucial to know. Initial coin offerings (ICOs) and DeFi are both important for tax professionals to understand.
ICOs work a lot like initial public offerings (IPOs) of stock, but they may differ in their tax treatment. Receiving a crypto token via an ICO may be treated as income at the time that the token is received, or the token may be classed as a capital asset subject to capital gains tax only when sold. The tax treatment for tokens produced by ICOs varies across jurisdictions.
DeFi, on the other hand, uses blockchain technology to eliminate the need for financial intermediaries like banks. DeFi platforms support a wide range of transactions that include buying, selling, trading, lending, and earning interest on cryptocurrency. The complexity and diversification of the activities occurring on DeFi platforms can create a challenge for tax professionals, in both understanding how DeFi works and interpreting the tax implications that arise from clients’ DeFi transactions.
4. Monitor the regulatory landscape
The regulatory landscape for digital assets is evolving at breakneck speed. Federal agencies in the United States are suing major industry participants and fighting over whether and which cryptocurrencies are securities. Lawmakers and regulators in the United Kingdom are making strong moves to classify cryptocurrency as a regulated asset. And jurisdictions like Hong Kong are increasingly opening up to attract more crypto and web3 businesses.
Tax professionals need to become knowledgeable about the crypto regulatory landscape and pay close attention to what’s changing. What’s true today about crypto regulation can easily be false tomorrow — and clients are relying on their tax professionals to know what’s happening.
Fortunately, there are a few different options for tax professionals to stay well informed in this area, including subscribing to reliable news sources that focus on crypto issues, reviewing official regulatory announcements, attending cryptocurrency taxation webinars, and joining professional forums for crypto tax professionals.
How crypto transactions are taxed, how information is reported, and what penalties apply for non-compliance all have the potential to evolve as the crypto industry matures. By monitoring crypto news and trends, tax professionals can ensure that they stay on top of all changes that matter for tax.
5. Engage with crypto communities
Tax professionals can significantly enhance their understanding of cryptocurrency and crypto taxes by engaging with crypto users directly. Participating actively in one or more of the many crypto communities is a solid way to stay informed about the latest trends, tools, and challenges that matter to crypto tax clients.
To become more active in a crypto community, tax professionals could begin to use channels like Telegram, Discord, and Reddit to participate in focused crypto forums or engage in other social media discussions about crypto. Tax professionals could also attend meet-ups of crypto groups or cryptocurrency conferences, or even join or organize a crypto tax webinar.
Engaging directly with crypto users is important because it keeps your crypto knowledge fresh — and may even provide new leads additional tax business.
6. Use crypto tax software
Tax professionals wishing to streamline the accounting and reporting process for cryptocurrency taxes can opt to use crypto tax software. Using a comprehensive software tool is how many tax professionals — especially those new to crypto — ensure the quality and accuracy of their work.
Most of the crypto tax software on the market can perform a variety of tasks more quickly and efficiently, including allowing the user to connect with multiple blockchains and exchanges, automatically import cryptocurrency transaction data, record and track many different types of crypto transactions, and process more complex crypto transactions. User can also calculate gains and losses using appropriate cost basis methods and efficiently generate customized tax reports for their clients.
These crypto tax software solutions can save valuable time and resources for tax professionals and their clients, as long as professionals are careful to choose crypto tax software that is reliable, secure, and in sync with current laws and regulations.