I am happy for you. If you are reading this article, I am sure it's for a good reason. So now that we know you did the right thing at right time, that is, bought and/or sell bitcoin or other cryptocurrencies in 2017, you now have gains that you need to pay taxes on. The size of gains, depending on how you did in Q4 of this year, can be substantial.
While that is a good problem to have, are you prepared for the tax time? If you haven't, you may want to tidy things up in your accounting and tax record-keeping.
If you made significant gains this year, and have not paid advance tax, then you'll be paying interest and penalty. So look at your records and see where you stand.
You still have about 2 weeks that you can use for some tax planning if you have not done already. In most part, this really is about capital gains and trying to minimize those. More on this in some other sections of this article.
Taxable Income -
So the good news is that not all the money you made is taxable, yet. The cryptocurrencies are capital assets. So you don't count the appreciation as taxable income until you sell/dispose of such capital asset. So it'll be a good idea to now gather your records, and figure out what you sold and what did it cost and calculate capital gains.
Long-Term Capital Gains (or Loss)
If you held these assets for more than one year (that is, one year plus one day), that makes the capital gain on this long-term capital gain. This is good for you since the rates are lower on long-term (can be even 0% depending on your tax bracket).
Minimize 'Realized' Capital Gains
You can minimize the capital gains if you plan well. You can 'specifically identify' the lots that you are selling. While the most common method is First In First Out, which is basically saying that you sell the oldest lot first, there are other methods. One is the Highest Cost First Out, meaning, you sell the lot that was bought at the highest per-unit price. This should result in lower profits. In the scenario of the rising price, LIFO (Last In First Out) will also give you roughly the same results, but only for a short period.
What can you plan
You can do two things:
- One is lowering the total amount of capital gains by using the higher cost lots for closing.
- Second is to try to generate long-term capital gains instead of short term. So even if the amount of capital is roughly the same, you pay a lower rate of taxes.
There are some other topics you should consider as part of tax planning around your cryptocurrency trading:
- Recently launched futures on Bitcoins and Index Reference Rates are going to be eligible for IRC section 1256 treatment. Which means 60% of the gains are automatically treated as long-term.
- The exchange of one cryptocurrency for another may or may not qualify as the like-kind exchange under IRC sec. 1031.
- Depending on how you traded/held the cryptocurrencies in your portfolio, the expenses to generate this income may be subject to 2% floor in expense deduction.
DISCLAIMER: I have written this article to share some knowledge and is not intended to be tax advice by any means. If you need professional advice, please consult your tax adviser or us for your specific case.
We offer our portfolio accounting software, Seamless Suite, to buy-side investment managers, traders, investors. You may contact us if you'll like to utilize our services/software for the accounting of your cryptocurrency portfolio (including partnership allocations, fee calculations, and full general ledger bookkeeping for hedge funds) for your tax planning purposes.
Written By: Nilesh Sudrania, CFA, CPA