Now that tax season is in full swing, taxpayers who participated in last year’s boom in cryptocurrency and other digital assets like non-fungible tokens (NFTs) are figuring out what it all means for their taxes.
For investors without tax savvy, navigating surprise tax bills or complex crypto tax situations could be a challenge during the filing season, so it is important to be well-prepared. Even if cryptocurrency aims to be an alternative to the U.S. dollar, it does not change Americans’ tax obligations.
The Internal Revenue Service (IRS) treats cryptocurrency and other digital assets like property, meaning a taxpayer may owe tax when they exchange or sell assets for a profit. Tax may be due even if a taxpayer exchanges assets for a good or service, such as buying a vehicle with cryptocurrency from e-commerce sites like eBay.
While the policy discussion in Washington, D.C. has focused on tax reporting rules for crypto transactions, the rules are not scheduled to kick in for several years. Taxpayers are not, however, released from reporting their transactions to the IRS. This year’s individual income tax return asks up front: “did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” The question is meant to remind taxpayers about their crypto transactions while making it harder for people to ignore their tax obligations.
The tax filing season may also be tricky for crypto investors because of an overwhelmed IRS. The nation’s tax collector is still catching up on last tax season and issued a public service announcement earlier in the year telling taxpayers to be patient for their returns. Because of the backlog, it will be difficult to contact someone at the IRS if a taxpayer has questions about how they should approach their crypto transactions. Even professional preparers may run into difficulty, particularly when helping taxpayers who did not record their crypto tax basis and engaged in a high number of transactions.
It’s not all bad news, though, as crypto investors may see some upsides this year. The volatility of digital assets resulted in many taxpayers selling at a loss, which can in turn be used to offset crypto gains, or even gains from other sources. In fact, taxpayers may even buy back digital assets within 30 days of selling at a loss without losing the value of the loss deduction. The process, known as a wash sale, is banned for most other assets – investors must wait at least 31 days to repurchase a stock, for example, and still be eligible for a loss deduction. As with many evolving tax issues, don’t expect wash sales to be fair game forever – Congress is considering rules to treat crypto like other financial assets, including barring the use of wash sales.
Policymakers have a few options to help taxpayers who are new to trading digital assets and dealing with complicated tax situations. Among them, providing a small exemption for realized gains because the compliance costs associated with paying taxes on small gains outweigh what little revenue would be raised.
Taxpayers can help themselves by following general best practices when it comes to filling taxes: start the process early in the tax season, ensure proper documentation of transactions, and know when to get extra help by contacting a professional tax service. Taxpayers have until April 18th in most states to file their returns, and it’s better to get it right the first time than to get it wrong and be in a prolonged back-and-forth with the IRS.
By following best practices, taxpayers with crypto-related income are much more likely to have a smoother tax filing process amid all the challenges they will face this year.
