When it comes to calculating the tax consequences of investing in crypto, there are two different methods: the highest-in-first-out cost-basis method and the last-in-first-out cost-bass method. The highest-in-first-out method keeps the gains and taxes low, while the last-in-first-out method requires you to sell your most recent crypto first. Although this is more beneficial when the value of your crypto is increasing, it also requires you to keep thorough records.
Short-term versus long-term capital gains
Crypto currency investors and traders should consider the tax implications of long-term and short-term capital gains. Long-term crypto trading may save them money in taxes, as long as the crypto is held for a year or more. Short-term trading, on the other hand, may be better for tax savings. In a recent article in The New York Times, tax expert David Axelrod wrote about the importance of calculating crypto capital gains in advance.
The tax rate varies, and both types of capital gains are subject to different rates. The short-term capital gains tax rate is generally 10% and the long-term capital gains tax rate is 15%, plus NII for higher-income individuals. The tax rate on long-term capital gains is lower because you do not have to sell crypto or participate in taxable events to recognize your profit. However, Chandrasekera recommends using the highest-in-first-out accounting method.
Tax rates on cryptocurrency capital gains will vary by income level. For example, those who earn more than $1 million per year will pay up to 39.6% of their income in capital gains taxes. Most crypto traders will not be affected by these proposed changes. However, those who are subject to nearly doubled tax rates will be less likely to hold on to their investment over the long term. Here’s an overview of what those tax rates mean for you.
For cryptocurrency investors, reporting will be more complicated. The IRS is cracking down on people who try to avoid taxes through cryptocurrency sales. The IRS has issued guidance on cryptocurrency taxation since 2014, but only a fraction of people are actually reporting these transactions. It’s up to the individual to track all taxable activities and keep track of their currency’s fair market value. The IRS has a list of tax rates for these types of transactions.
There are three main methods of calculating capital gains on cryptocurrency transactions: first-in-first-out (FIFO), last-in-first-out (LIFO), and highest-in-first-out (HIFO). Each method is different, but they have one thing in common: each counts specific assets in different chronological order. As such, they produce different capital gains numbers. FIFO counts coins bought first, while LIFO counts coins sold last. LIFO is often better for traders who buy large quantities of crypto, and it is also a good option for those who buy small amounts of coins.
The HIFO method requires extensive and tedious bookkeeping. It requires meticulous records and requires investors to keep track of each coin transaction. Without accurate records, calculations to the IRS are impossible to make. One method of calculating capital gains on crypto transactions is the wash sale rule, which lets investors benefit from recent losses by selling coins with the highest cost basis first. Using this method will reduce your taxes by 80% to 97%.
Losses you can offset
If you sell crypto assets for a loss, you may qualify to offset the loss on your taxes. Crypto assets do not fall under the wash-sale rule. This rule prohibits investors from selling losses on a cryptocurrency and then rebuying the same crypto asset within thirty days. This creates a tax loophole for savvy investors. Unfortunately, this provision is not yet in place in the United States.
In the meantime, there are ways to offset your losses on crypto. Depending on the type of account you hold, you may be able to carry forward losses to future years and reduce your capital gains. But note that you cannot claim a loss for a crypto asset you sell without selling the rest of your assets. While you can offset the entire loss on crypto, you cannot carry forward the losses from a previous year to a future tax year.