In crypto circles, one of the most common sentiments is that crypto trading and profits are not taxable until you convert them back into a fiat currency.
“Yeah, but you don’t pay taxes until you trade it back for USD. So long as you don’t cash out you don’t have to pay anything!”
That would be great – if it were true.
Crypto Bros Don’t Know What They’re Talking About
Unfortunately, it’s just not. A taxable event is created each and every time you convert one token for another. Every trade will generate its own capital gain or loss that must be cataloged and reported on your tax return to the IRS. The IRS noted this very plainly in a follow-up FAQ to IRB: 2014-16 (emphasis mine):
“Question: Will I recognize a gain or loss if I exchange my virtual currency for other property?
Answer: Yes. If you exchange virtual currency held as a capital asset for other property, including for goods or for another virtual currency, you will recognize a capital gain or loss. For more information on capital gains and capital losses, see Publication 544, Sales and Other Dispositions of Assets.”
Crypto Trading Presents Unique Difficulties
This can be a bit of a logistical nightmare for two main reasons:
- The prices and exchange pairs of each cryptocurrency are constantly fluctuating
- In order to avoid understating your cost basis – and thereby not overpay on your taxes – you need to keep track of gas fees and exchange fees
Let’s just run through a basic example to illustrate this. Let’s say you have some BTC that you originally bought for $1,000. The market goes up and the value has increased to $2,500 and you decide to swap it for an equivalent amount of ATOM. Then the value of the ATOM goes down to $2,300 and you decide to swap it for KAVA.
Contrary to what people in Discord might tell you, you have taxable income that you must report even though you did not convert it back into USD. And it’s not just the net of $1,300 that needs to be shown. You have to show the capital gain of $1,500 ($2,500 – $1,000) and the capital loss of $200 ($2,300 – $2,500). You will also need to keep track of any costs associated with the $2,300 purchase of KAVA and also the date purchased to see if you qualify for long-term capital gains treatment when it is sold.
I’ve noted this before, but I believe the confusion on this stems from the fact that in most other transactions actual cash is received. We generally don’t function the barter system. You sell a stock, your house, or pretty much anything of value and cash is received. So – somewhat understandably – people attach the receipt of cash as what generates tax. But it’s not. The disposition of the asset is a taxable event, not the receipt of cash itself.
How to Stay Compliant and Track Your Crypto Trades
So each crypto trade generates its own reportable transaction and gain or loss. Which can cause a bunch of issues, some of which we’ll cover in-depth in their own articles:
- Since you didn’t convert the crypto back to cash, you may not have the money to pay the tax bill on the crypto profits without liquidating some of your portfolio. And that liquidation will cause more capital gains or losses
- If you have large gains in one year but then the market goes down the next, you could have a massive tax bill and no means to pay it
- Unless you have all of your transactions on one exchange, your cost basis is not being tracked properly. The IRS receives much better records of sales than they do for your cost, so if you aren’t keeping track of the transactions yourself it’s very likely that they’re going to think you made more money than you did
- Some exchanges do not do a great job of including their fees in your cost basis for tax purposes. And if you are using a decentralized wallet like MetaMask, your cost basis is not being tracked at all.
- The holding period resets for long-term capital gains purposes resets after each trade
This would be tedious to track even with a limited portfolio, but as I’m sure you can tell this would be nearly impossible at any sort of volume. That’s why we recommend using a crypto tracking software like CoinTracker.
As always, make sure you’re consulting with your CPA throughout the year to make sure you’re planning properly and taking advantage of maneuvers to minimize your tax bill on your crypto profits.
Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
