As we talked about cryptocurrency last week, it occurred to me that many of the younger people that are investing in this may not know how the taxes work. We talk about cost basis and gains and losses, but even these concepts are not as easy as they first appear.
Where do we start?
- Let’s start with cost basis. Seems pretty easy as first since it is basically what you originally paid for the virtual currency, but you can calculate your basis in more than one way. And the way you calculate it can have big difference on how much tax you need to report each year.
What are the different ways that cost basis can be calculated?
There are two ways to calculate it-
- Specific lot and average cost.
- Specific lots are when you keep track of every time you buy or sell any virtual currency.
- The advantage of this method is that when you sell, you can pick from all the lots to see what will produce the least amount of gain.
- The disadvantage of this is depending on how many times you buy, it can be time consuming to keep track of. Excel is your friend here.
And average cost?
- Average cost is where you take your total amount owned and compare it to the total paid and that average is what is used anytime you sell.
- In this case, there is no way to play with your gain, since your cost basis is the average.
- This is easier though since you don’t need to keep track of each purchase and remember which ones were sold and which were not.
So every time that there is a sale, there will be a gain or a loss that needs to be reported.
- What some people will do is to invest a certain amount and then when the price goes up, they will take out their original investment and play with the profits from that point on.
- In this case, even though you are taking out your initial investment, it is not tax free since that cost basis is spread out over all the shares that you own, not just the shares that you sell.
Then it is important to remind people that there is a difference between short term and long term?
- Yes, it really makes a difference whether you hold it for over a year or under a year.
- If you hold it under a year, the tax rate is the same rate as your ordinary income just like wages, pensions etc.
- If you hold it for over a year, then the capital gain rates apply. This could be a 10 – 15 – or even 20+ percentage points different. So for a $10,000 gain, this could decrease your tax by $2,000.
Lastly, as a reminder, there may be losses that cannot be claimed right?
- Yes, on previous weeks we talked about wash sales. Do a quick internet search, since this can impact your decisions.
Cryptocurrency taxes can be more complex than a person might think, so it is a good idea to talk to a tax professional.