As a basic instinct of human nature, we explore various investment opportunities and financial vehicles to grow our investments. Cryptocurrency trading is a fairly young market and there are a lot of gray areas one needs to be aware before jumping into it.
Also, this is a relatively new market with a lot of rules not etched in stone right away. So, it’s important for traders and investors to be wary of various implications either legally or financially. Here are 5 ways how you can be prepared for cryptocurrency taxes ahead of time.
1. Keeping good records of your trading history
Trading on cryptocurrency exchanges is done against various pairs, unlike capital markets where it is done against national currency (fiat currency).
Example: In NYSE, TSLA (Tesla Stock) trades for USD
However, a cryptocurrency like Ethereum is traded on Binance with multiple pairs like BNB, BTC, XRP, USDC, USDT, USDC, PAX.
It is really important for you to keep track of these trades as every trade generates a taxable event. Even when you are trading one cryptocurrency into another cryptocurrency is a taxable event.
Choose exchanges that provide transaction history, so that it makes your life easy when it comes to taxes. You should be able to export to CSV or fetch your trades via API. This will ensure you know what you are playing with and how much is the price paid along with fees paid.
2. Choosing the right exchanges & being secure
As a cryptocurrency trader, it is common to have accounts on various exchanges and trade different coins on different exchanges. Choose exchanges wisely depending on their credibility and operational success. Chasing new ones might leave you with a runaway situation.
Use a password manager to generate strong passwords which are not reused across other exchanges which are vulnerable to hacks.
It is important to keep track of the functioning of exchanges. There are quite a few instances where some of the exchanges were taken down by hackers or went defunct because they lost funds or had to shut down operations due to legal issues.
In such cases, it is impossible for you to get your transaction history unless they are kind enough to respond to your support request. This is another reason why you need to download trade history regularly and choose the right exchanges.
3. Stay aware of updates on exchange policy
As said earlier, this is a fairly young space and a lot of developments happen at a rapid pace. Given this, Exchanges have to continuously upgrade their systems and the way they serve their customers.
As a customer, it’s your duty to follow their policies and make a not if they are going to provide the historical trades or not.
If they are not going to provide something related to your trade history after a certain period of time, it is important for you to download this and store it securely for tax filing purposes.
4. Track addresses for token sales & mining transactions
If you are into mining or working as an affiliate for a specific cryptocurrency project or working as a community manager for an ICO, there is a good chance that you fall into the category of earning cryptocurrency as an income.
This is taxed differently compared to trading. Here, you get the cryptocurrency as a deposit to your registered wallet regularly or one time. You need to keep track of these addresses (often alphanumeric and up to 50 characters in length). Yeah, that sounds crazy, but it’s early days and we need to live with it.
Since the cryptocurrency earned through mining or salary is taxed as income, you need to have addresses and records of it to claim it as income and taxed in a separate lower rate, unlike short term capital gains.
5. Prepare early to save and avoid mistakes
Things are easier said than done. Keeping track of all these things is hard when you are heads-down focused on analyzing technical and fundamental factors of every cryptocurrency project and trade them to make some green.
However, it’s a good practice to play by the rules and be prepared with all the required transaction history, wallet addresses and use the right exchanges.
This will help you save spending a ton of money on CPAs and instead use self-help tools to calculate capital gains and file taxes.
If you prepare early, due to the lack of rules around wash sales and loss harvesting, you can sell at the end of the year and buy back to claim losses (if prices are significantly lower at the end of the year than the beginning).
Also, if you prepare in advance and have all transaction history, you won’t miss any trades and never have to pay any penalties for amending taxes or paying additional interest on taxes you owe.
6. Avoid trading out of adrenaline rush or pump & dump signals
A sincere request to all those retail investors, who trade during a bull market while prices are pumping, it is interesting to see you make some decent profits, but each trade triggers a taxable event and you owe taxes in USD at the end of the day, which means if you made profits in XRP and never sold it for USD. You will have to pay taxes on hefty gains you made.
Here’s an example to explain this
Capital Gains or losses will be defined by the trading frequency and whether it’s in bull vs bear market. Also, it completely depends on the number of trades made. Like if you were buying and selling while it’s moving up and finally bought at the top and holding it now (after it went down), You will still be in profits even though your bag now is worth a lot less.
Say, You have invested $100 in ABC (random coin)
You made $100 into $200 (bought at 100 and sold at 200 making $100 profit), re-invested and made $200 into $300, again $300 into $600, again $600 into $1000 and finally you bought at $1000 and never sold after, which let us say is worth $60 now!
So, you made profits of 100+100+300+400 = $900. But, you’ll be looking at your portfolio and think you are 960$ loss from what your last purchase and $40 in reality.
Sadly, for this year you will be owing taxes on $900 and you may claim your losses when you sell the asset you are holding.
People often get confused between portfolio and capital gain/loss — these two are different and the example above shows it. So, don’t trade out of rush or following somebody’s signals. Trade with responsibility.