The tax season deadline is fast approaching, but to investors and their accountants involved in the crypto space, there’s still a massive amount of uncertainty as to how to handle tax returns where cryptocurrencies are concerned.
This year will undoubtedly be more troublesome than the last. The Bitcoin rally at the end of 2017 caught the attention not only of retail and institutional investors but of the tax agencies. Since then, trends in the cryptocurrency markets have been overwhelmingly bearish, and many investors are contemplating realizing their losses to offset other tax liabilities.
To top it all off, it’s become clear that tax agencies are now working with exchanges to share access to US customer activity data. It seems very much like the ‘Wild West’ days of cryptocurrency are coming to an end, as regulators get to grips with the rapidly emerging asset class. Of course, with limited guidance given out by the IRS on the matter, the burden is on investors and their accountants to ensure their returns are filed correctly.
Unfortunately, most seem to be going about this the wrong way.
Tracking and Taxation
Above all, the most important prerequisite to properly reporting cryptocurrency gains (or, more likely, losses) is keeping records of every deposit, trade, and withdrawal made, whether crypto-to-fiat, fiat-to-crypto or crypto-to-crypto. Evidently, this is much easier for an individual that makes a few trades yearly on a single exchange, versus a high-frequency trader executing hundreds of trades a week across multiple exchanges. Add to this the fact that addresses can be scattered across several wallets, and the complexity of the task begins to manifest itself.
It’s nonetheless critical to track the lifecycle of each individual UTXO (from acquisition to disposal) as it travels from wallet to wallet in order to adhere to the best reporting practices and to withstand IRS scrutiny. It’s incumbent upon the investor to align their calculations with an accepted standard, or methodology. The Generally Accepted Accounting Principles (GAAP) established by the Financial Accounting Standards Board (FASB) in the U.S. is an obvious place to start. FASB accepts both FIFO (first in, first out) and LIFO (last in, first out). Alternatively, the internationally recognized International Financial Reporting Standards (IFRS) is a good standard, though it only supports FIFO.
Other methodologies can be adhered to as well (HOFO, LOFO, etc.), though may carry less weight if the investor is faced with an IRS challenge. All options should be discussed with an accountant to ascertain which is the best fit.
Record, Record, Record
We’re currently at a frustrating stage where there is an obligation on investors to report accurately, but little guidance enabling them to do so. It’s unfortunate, but it should be accepted just another growing pain of the nascent cryptocurrency space.
While the markets tread level or downward, now is be a good time for investors to consider harvesting their losses for the purposes of offsetting other gains. By doing so, they should be aware that putting themselves on the radar in this manner requires a rolling commitment, and that they should not fail to file in subsequent years.
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In the interim, there’s no substitute for keeping up-to-date records of every transaction made. When it comes to taxes, nothing is more important than having an extensive audit trail that can be demonstrated to auditors upon request. Already, we’re beginning to see accounting software emerge that does the heavy lifting, interfacing with exchanges and user wallets to pull data and run all of the necessary calculations automatically. Regardless of the state of regulation, solutions such as these should be employed to remain as in-line with tax agency requirements as possible.
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