How is Crypto Taxed? The Accountant's Guide

Although the IRS has stated that cryptocurrencies are subject to taxes, it can be difficult to interpret this guidance, especially for those who are not familiar with taxes. As a result, many American cryptocurrency investors hire a crypto accountant to assist them with their taxes. In the United States, crypto accountants are in high demand, so it is beneficial to know the crypto tax rules. We have provided all the information you need to know about cryptocurrency taxes in our USA Acccountant’s Crypto Tax Guide.

As the popularity of cryptocurrencies increase, so does the demand for accountants skilled in navigating crypto taxes. Although many accountants are hesitant to get into the cryptocurrency market because they lack understanding about it and because the IRS has not provided comprehensive guidance about the various transactions and their potential tax implications, some are choosing to expand into this new market.

Don’t worry – we’ve gathered all the resources you need in our USA Accountant’s Crypto Tax Guide, with the latest guidance from the IRS.

Crypto is an asset

If you want to figure out how to taxes on crypto, you should think of it as an asset instead of a currency. The term “asset” is the key that will help you unlock the mystery of crypto taxes.

An asset is anything that you own that has economic value and is expected to provide a future return. This includes shares, investment property, collectibles, and cryptocurrency. Cryptocurrencies should be thought of as property and an asset for tax purposes.

Most countries in the world have this as a case, with El Salvador being a famous exception.

Capital Gains Tax

Just like shares and investment property disposals, cryptocurrency is also subject to Capital Gains Tax.

When figuring out how much tax is owed on crypto gains, all the same considerations apply as usual – you’ll need to know how much the crypto asset cost in the first place, how much it was worth when it was bought and sold, and convert all the figures into your client’s local currency. Depending on your country’s tax rules, a crypto capital gain, or capital loss, could be triggered by 4 disposals:

Selling crypto like Bitcoin, into any fiat currency, like USD.
Swapping crypto for crypto, like Bitcoin to Ether.
Using crypto to buy goods or services.
Giving crypto as a gift, depending on your country.

Capital Gains Tax free threshold

In countries with a Capital Gains Tax free threshold, crypto gains should be exempt from taxation. This is the amount of money you can earn in a year without paying any income tax In the UK, taxpayers are allowed to earn £12,300 in a year without paying any income tax.

Capital Gains Tax discount

In countries where there is a discount for holding capital gains, crypto is usually given the same discount on disposal.

USA: The IRS applies a lower Capital Gains Tax rate of 15% or 20% for assets held more than a year.
Australia: The ATO gives a 50% discount on capital gains from assets held more than a year.
Germany: German taxpayers who hold crypto for a year or more pay no tax on profits from disposals.

Income Tax

Cryptocurrency income can come from either work or investments, and is subject to taxation under the Income Tax laws. In terms of cryptocurrency, the parallels look roughly like this:

Getting paid in crypto – like a salary.
Staking rewards – like dividends.
Mining tokens – like income.
Airdrops – like bonuses.
DeFi interest – like bank account interest.
Referral bonus – like commission.

Buying crypto is tax free

Under most tax laws, you don’t have to pay taxes when you buy an asset for investment purposes. However, you may have to pay goods and services tax/value added tax. Your crypto investor clients will not have to pay taxes on their cryptocurrency purchases if they use fiat currency.

Similarly, if you are the recipient of a gifted cryptocurrency, you will not have to pay any taxes – although there are some tax offices that do not follow this general rule, so make sure to check the rules for your location.

While cryptocurrencies are not taxed when bought, your clients will most likely have to pay Capital Gains Tax when they sell.

Clients could pay both Income and Capital Gains Tax

Cryptocurrency is seen as having two separate events: how it is received and how it is disposed of. If your client were to receive crypto via an airdrop in January, and the coins were worth $50, that would be great. This means that the $50 will be counted as part of their total income when determining how much tax they owe. In June, they decided to sell their airdropped coins for US dollars.

Those same coins are now worth $80. The people gained $30 because they were given $80 worth of coins and they only had to pay $50. When they dispose of the property, they will need to pay Capital Gains Tax on the $30 profit, even though they already paid Income Tax on the original $50.

Cost basis

The amount you spend to acquire an asset, including the purchase price, transaction fees, brokerage commissions, and any other relevant cost, is referred to as the cost basis. Crypto assets are handled in the same way as other assets. To calculate the cost basis for cryptocurrency, we simply take the purchase price plus any fees incurred and divide it by the number of units purchased (if applicable). If a client acquires cryptocurrency through an airdrop, they should use the fair market value of the cryptocurrency in their local currency on the day they received it.

If only it were that simple! Most clients are not dealing with single units of cryptocurrency. Most people have multiple assets and will need to follow an acceptable accounting method to calculate their cost basis. Permissible accounting methods vary depending on where you live, but some of the most common include:

Average Cost Basis method

This accounting method is the simplest one. The Average Cost Basis is calculated as the total amount paid to purchase the cryptocurrency divided by the total number of cryptocurrency units held.

There are two different ways that Canada and the UK account for cryptocurrency – the Adjusted Cost Basis Method used by the CRA and the Share Pooling Cost Basis Method used in the UK. The IRS in the US does not allow investors to use the Adjusted Closing Balance method to determine the cost of their holdings in cryptocurrencies or any other assets.

First In, First Out method

The basis for calculating the cost of cryptocurrency is the assumption that the first cryptocurrency sold is the first one bought. Widely used, benefits long-term holdings & a bull market. FIFO is the most commonly used accounting method in Australia, the USA and many countries in Europe.

Last In, First Out method

This calculation is based on the assumption that the first cryptocurrency that is sold is the last one that is bought. This results in lower taxable profits for crypto businesses.

Highest In, First Out method

The cost basis of a sale is the original value of the purchased cryptocurrency minus any losses. This means that assets with the highest cost basis are sold first. A larger cost basis minimizes your client’s capital gains.

How does the IRS view cryptocurrency?

It is important to understand how the IRS sees cryptocurrency in order to know how it will be taxed. We’ll keep it brief and expand with examples after, but here’s the ten-point summary:

The IRS treats virtual currency as property for Federal Income Tax purposes.
Virtual currencies are a digital representation of value that function as a medium of exchange, a unit of account or a store of value. Cryptocurrency is a type of virtual currency that uses crypto.
Although some virtual currencies operate like a fiat currency – virtual currencies do not have legal tender status in the US.
The sale or other exchange of virtual currencies, as well as the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, has tax consequences that generally result in a tax liability.
The tax treatment of crypto assets depends on how investors transact with them.
In general, the tax principles applicable to property transactions apply to transactions using virtual currency.
When an investor sells (or otherwise disposes of) virtual currency, they will recognize a capital gain or loss.
Many transactions are considered income, including hard forks, airdrops, mining and (currently) staking.
Transfers of virtual currency between wallets or addresses owned by the same investor are non-taxable events.
If an investor owns multiple units of one kind of virtual currency, with different basis amounts, they should specifically identify the basis of the units when calculating gains and losses. If they are unable to do this, FIFO is the standard accounting method.

Accounting method

Most American crypto investors hold multiple cryptocurrencies and dispose of them throughout a single financial year. They have to choose and follow an accounting method.

The IRS allows investors to identify which units of the same kind they have disposed of when using the specific identification accounting method. If an investor is unable to use specific identification, the IRS states the following accounting methods are allowed:

First In, First Out (FIFO).
Last In, Last Out (LIFO)
Highest In, First Out (HIFO)

Otherwise, if an audit occurs, the IRS could potentially assess taxes and penalties based on the IRS’s methods. The IRS warns that if investors do not have records proving they followed one of the accounting methods above, they could be subject to taxes and penalties based on the IRS’s methods if an audit occurs.

Looking at some examples of different transactions and their tax implications will help to better understand how taxes work.

How crypto accountants can help investors

Accountants know that preparing for the April tax deadline takes preparation – and this is especially true when it comes to crypto taxes.

The Koinly software can help your clients with things like reducing their tax liability by tax loss harvesting and choosing a favorable cost basis method, as well as generating reports that meet IRS requirements.

Koinly helps you track your realized and unrealized gains and losses in one place, supports a variety of accounting methods including FIFO, LIFO, and HIFO, and generates IRS-compliant tax reports, so you’re ready for the April 15 deadline.

How to calculate and report clients’ crypto taxes

In general, there’s five steps to calculating and reporting crypto taxes with the IRS:

Calculate the cost basis of each crypto asset, or the fair market value (FMV) of the crypto asset in USD on the day it was acquired.
Identify each taxable transaction and the type of tax that would apply – whether that’s Income Tax or Capital Gains Tax.
Calculate capital gains and losses from each disposal of crypto, including separating short-term and long-term capital gains. Tally up capital gains, minus any losses for a net capital gain or loss.
Identify the fair market value in USD of any crypto income on the day it was received.
Report these final figures to the IRS using a tax tool like TurboTax or TaxAct, or file with paper forms.

The tax forms that need to be filed for crypto will depend on the individual’s investments and whether they are filing as an individual or a business. However, in general clients will need:

Individual Income Tax Return Form 1040. Form 1040 is the standard individual Income Tax Return form which all taxpayers must file.
Schedule D and Form 8949. Each individual disposal of a crypto asset must be reported on Form 8949, and net capital gains and losses from Form 8949 reported on the Schedule D.
Schedule 1. Crypto income from airdrops, forks, DeFi protocols, bonuses and so forth should be reported on Schedule 1.
Schedule C. For self-employed investors, or clients operating a crypto business, income from crypto should be reported on Schedule C instead.
FBAR. Any investor who has fiat currency or specified foreign financial assets worth more than $10,000 in combined value should file the FBAR form. Please note, if a client is only transacting with crypto (including stablecoins), this would not apply.
FATCA. Any investor who had fiat currency or specified foreign financial assets worth more than $50,000 on the last day of the financial year (or more than $75,000 at any point during the financial year) must file a FATCA. Like above, this form is only necessary for fiat, if a client only held crypto assets, this form would not apply.

Many exchanges also issue different types of 1099 forms, including 1099-K, 1099-B, and 1099-MISC forms. If you are filing the forms mentioned above, you may also need to use these forms. The IRS is currently developing a 1099 form specifically to report crypto assets.