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This article was originally published in Blockchain Industry Review - a Crypto Curry Club Magazine published monthly and available in soft copy and the printed version.
Written by Guest Contributor Peter Johnson,
Head of Business Development at Accointing
It’s easy to get excited by crypto, with many following the latest crypto crazes, moving from one cryptocurrency to the next, trying to jump on the next new hot coin, never thinking of what the tax implications might be of what they are doing until it is too late and the taxman comes calling. This can be particularly dangerous in a bull market – as we find ourselves in today. Many crypto traders and investors don’t realize that when they move from one cryptocurrency to the next, they are creating taxable transactions – they have sold one cryptocurrency to buy another. It is that sell transaction that the tax authorities are interested in.
The tax authorities view the sale of the first cryptocurrency as a taxable event and they want to know how much the trader or investor paid for that asset when they bought it. In a bull market, the chances are that the trader or investor paid a lot less for the coin or token then they sold it for – which means they made money. The taxman wants his share – and sometimes that’s a large share. The user may have actually just created a tax liability without realizing it, and more importantly, without having allocated any fiat currency (BP) to pay for that tax liability. And don’t forget – you can’t pay taxes with crypto yet. The new crypto that was bought – because it is a bull market – has been purchased at a relatively high price – perhaps the all time high. All this is fine and good as long the market stays high.
The problem is when we move into the next tax year. There might now be a significant tax liability in the previous year from selling our first coin – but taxes aren’t due to be filed and paid until 9 months later. The tax year ends on April 6, but we have up to January 31st of the following year to file and pay our taxes. A lot can happen in 9 months, and if it’s crypto, with massive bull runs, there can also be huge corrections – just look at a chart for BTC.
By the time that tax bill comes due – the market might have dropped and the new crypto we are holding, perhaps what we thought we would use to pay our crypto taxes (if we thought about taxes at all) may now be worth only a fraction of what it was worth when we bought it. We can still sell it – but perhaps it’s at a new recent low and the worst time to sell – and it may not even be close to enough to pay our tax bill. Even though we have losses in the current year – we can’t use those losses to offset our taxable gains for the previous year. We can end up paying far more in taxes than we earned in Crypto. There are countless nightmare stories of traders suffering real financial hardships from failing to understand that basic truth about crypto trading - that taxes are due whether we have the funds or not. Never paying attention to the tax implications of moving from coin to coin can put us in a crypto tax trap.
But what can we do about this – other than just stop trading crypto – or not moving our holdings from one coin to another? Not everyone might want to do that! So then what?
The first thing we should do is be aware of the tax consequences of every trade we undertake before we make the trade. This can sound difficult and intimidating – but there are portfolio tracking tools available with tax optimization features that tell us where all of our coins are located, what was paid for them, and how much profit or loss is imbedded in each coin no matter how many times we have moved it or in what wallet it is held. These tools can help say what the tax implications are of any trade we make before a trade is made. These are tasks that even a professional crypto tax preparer if we can even find or afford one, will have difficulty helping us with.
Before we execute any trade, we also should know the answers to each of these questions. Will the trade cause a tax liability? In a worst-case scenario, will we have the funds to pay those taxes? If not, where will we get those funds when taxes are due? When will the taxes be due? Will the trade create a loss that we can offset against other gains? Should we set aside some fiat currency to pay for the taxes before the market has a chance to move against us? Can we delay our trade to a new tax year – so that we can use any losses occurring in that tax year to offset our gains? Should we trade a different coin with a better tax outcome? Should we donate certain coins to a worthy cause instead of selling them? What is our tax strategy anyway and how will we implement it?
This is where strict monitoring of positions and trades is critical. A portfolio management system that tracks the gains and losses of each coin is needed – regardless of where we transfer it to, in which wallet it is held, or on which exchange it is traded. This kind of information can help users develop a tax trading strategy that can prevent headaches, lower stress, and save money.
Meet Peter Johnson
Peter is responsible for maintaining Accointing as the number one portfolio and tax reporting software globally. This includes developing institutional business partnerships and overall business development strategies.