If you think that the U.S. Internal Revenue Service is all hung up on dealing with the COVID-19 stimulus package and will not carefully examine crypto reports — you had better think again. The IRS is taking steps to build cases against taxpayers who fail to report cryptocurrency, and after the new crypto tax guidance was published in October 2019, there are really no more excuses left to not report crypto activity.
So, if you have not filed your returns by now, here are the five critical mistakes in crypto tax reporting you want to avoid:
1. Do not report only part of your crypto activity
Cryptocurrency tax reports should be like any other tax report — true, correct and complete. Do not assume that you know which information the IRS has access to. The IRS can not only rely on the information provided with your standard tax return, but they can also combine information received from third parties such as crypto exchanges and payment systems, among others, to determine the validity of your crypto filing. Reporting only part of your crypto activity is not only gambling on the information available to the IRS, but it is illegal.
So, make sure you are collecting all of your data before submitting your report. This includes all your crypto transactions from all your crypto exchange accounts, all addresses from all your wallets, any income in or gifted crypto, mining activity, airdrops and forks.
2. Avoid using like-kind exchanges
U.S. tax law has a tax exemption for certain property exchanges called like-kind exchanges, under Section 1031 of the Internal Revenue Code. This is an asset transaction that does not generate a tax liability from the sale of an asset when it is sold to acquire a replacement asset.
The IRS clearly states that like-kind exchange treatment applies to real property and not to exchanges of personal or intangible property.
Moreover, the IRS has even specifically mentioned that like-kind tax exemption has never applied to crypto transactions.
3. Do not treat all your crypto transactions the same
Classifying your crypto transactions correctly is the only way to make sure you are reporting accurately. Remember:
- If you received payment in crypto for a service — it is an income.
- If you are mining crypto — it is also an income.
- If you traded in crypto, you have capital gains or losses. It is important to make sure if those gains or losses are short or long term.
4. Do not forget to establish fair market value for peer-to-peer transactions
If you acquired or sold cryptocurrency in a peer-to-peer transaction or traded on a non-facilitated cryptocurrency exchange, you need to establish an accurate fair market value, or FMV.
The IRS will accept the evidence of FMV from a blockchain explorer that calculates the value of the cryptocurrency at an exact date and time. If you do not use a crypto explorer, you must establish the value as an accurate representation of the cryptocurrency’s FMV.
5. Using the wrong tax form
After classifying your crypto transaction correctly, you need to make sure you are filing the right tax form. If you are not sure, or if you have more income and capital gain to report, you should seek a professional tax consultation.
If you have capital gains, use Form 8949, entitled “Sales and Other Dispositions of Capital Assets,” and then summarize your capital gains and deductible capital losses on Form 1040, Schedule D, entitled “Capital Gains, and Losses.”
If you have an ordinary income from crypto, use Form 1040, entitled “U.S. Individual Income Tax Return,” Form 1040-SS, Form 1040-NR or Form 1040, Schedule 1, entitled “Additional Income and Adjustments to Income,” as applicable.
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