It’s tax season in the US and the deadline for individual taxes is April 15th. Many crypto traders are wondering why they should even bother filing their crypto taxes, given that all they had were losses for 2018. Unfortunately, it is required by law to do so and if you don’t, you risk being audited by the IRS and paying penalties. It isn’t all gloom and doom though. Because if you had losses, you can utilize some strategies to minimize your overall tax liability and potentially increase your refund. In this article, we will cover some of the strategies you can use and what you should be aware of.
Capital losses are deductible
Your losses from crypto trading can be used in a few different ways. First, they can be used to offset any capital gains you had, whether it be from crypto, stocks, or even real estate. If you had more capital losses than capital gains, then you can use it to offset other income sources (i.e. wages, salary), but only up to $3000. Any remaining losses past $3000 carry over to subsequent years. So for example, if you make gains in 2019, your 2018 losses can be used to offset those. These rules apply to the U.S. but similar rules apply to other countries worldwide.
Several accounting methods are available
In order to calculate your gains/losses, you need to first select an accounting method. This dictates which coins you are selling or trading if you have accumulated a bunch over time. A few options include First-In-First-Out (FIFO), Last-In-First-Out (LIFO), Average Cost, and Specific Identification. FIFO is generally the most conservative option to choose, but since the IRS hasn’t issued strict policy on the accounting methods allowed for cryptocurrencies, it is widely assumed that all methods open for stocks are also open for crypto.
The accounting method that you choose can have a huge impact on your overall tax liability. However, the best choice depends entirely on your transaction history. For example, during a bull market, you may think that LIFO would give you the least amount of capital gains, because you are trading/selling your most recently acquired coins. However, if you use FIFO, some of those coins may be categorized as long-term (held for >1 year), in which case a lower tax rate would apply. So it really all depends on your situation. It is highly recommended to use a tax software to calculate and compare your total gains/losses per different accounting methods.
Let’s take a look at an example for more clarity. Imagine you bought 3 ABC coins:
- 1 in July 2017 for $2k.
- 1 in April 2018 for $7k.
- 1 in November 2018 for $5k.
You sell 1 ABC in December 2018 for $4k. What are the capital gains/losses for this transaction per each accounting method?
- FIFO: $4k – $2k (July 2017 cost basis) = $2k gain
- LIFO: $4k – $5k (November 2018 cost basis) = $1k loss
- Specific Identification: $4k – $7k (April 2018 cost basis) = $3k loss
Now you have a better idea of why the chosen accounting method can vary your final result greatly.
Tax loss harvesting
What if you held your coins all throughout 2018 and didn’t execute any trades at all during the bear market? In that case, you unfortunately have not realized any of your losses and can’t use it to deduct income or gains from other sources. But you can use your newfound knowledge about various tax optimization strategies and be prepared for next year. Specifically, you can utilize a strategy called tax loss harvesting.
In a nutshell, tax loss harvesting involves realizing those losses by determining which of your coins to sell and how many. The easiest way to do this is to use a crypto accounting software, such as TokenTax, so that you can be sure you don’t sell too many and potentially start realizing gains. As we’ve seen earlier, this could maximize your realized capital gains for 2019 and make a huge difference for you come next year!
Taxes are no fun, especially for crypto traders during a year long bear market. However, they must be completed and by utilizing various strategies and tools, you can make your life way easier. Definitely be sure to look into our recommendations more and if you have any questions, don’t hesitate to reach out to me at our Telegram group.