Owning and trading cryptocurrency is more mainstream than ever before. In fact, it’s estimated that over 60% of Americans may purchase cryptocurrency this year. Crypto trading must be reported on your tax return, and your CPA is a critical partner for weighing options to manage the tax implications.
If you are an active trader, there are tools and accounting methods your CPA can help you with to minimize the tax implications of your trading activity. No one likes surprises at tax season, and an accountant with expertise in crypto can help you proactively manage the tax implications of your trading activity throughout the year. Here’s how.
Consolidating your trade data
Trading on multiple platforms? Then, you already know that each platform provides you data for your transactions, often in the form of a spreadsheet. But, how do you keep track of all of your data?
Start by consolidating it. By using a program like Taxbit that takes all of the data files across multiple platforms and aggregates them, you will have a way to track gains and losses all in one place. Having everything in a single application makes it easier for you and your accountant to manage.
Choosing the accounting method for reporting crypto transactions
You are allowed to choose Specific Identification (HIFO is a popular specific identification method) or FIFO to establish your buy point for crypto.
HIFO means ‘highest in, first out.’ FIFO means ‘first in, first out.’
HIFO establishes the cost basis by using the highest price point you bought in at a cost basis, and this may be your most recent purchase.
The prevailing school of thought with HIFO is that by establishing the cost basis with the highest purchase, you can minimize your taxable gain.
Another option is FIFO. Assuming your first purchase yielded the lowest return, people often discount FIFO on the basis that later purchases might establish a higher cost basis for calculating gains. As with everything, there are exceptions.
Is HIFO always the best option for reporting crypto?
The more popular method for valuing cryptocurrency is HIFO. However, it’s important to look at it both ways. You might be surprised if/when FIFO is better.
Here is an example where HIFO can create more short-term gains and less long-term gains. If you choose the highest price and the highest price is everything you’ve bought in the past year, the gains are 100% short-term. You will pay a higher tax rate on short-term gains because you will be taxed at your ordinary income tax rate.
In a scenario where your total short-term gains are higher than the total long-term gains, you could be better off with FIFO. Why? FIFO takes the oldest buy point, which is often a lower price than the ones you bought recently at the higher price.
Looking at both accounting methods to establish the cost basis that yields the lowest tax liability can save you money, especially when planning for the long term.
What you need to do in 2022
The decision about which accounting method to use will impact your future gains and losses. Engage your accountant for advice.
If you are an active trader in cryptocurrency, it makes sense to be very strategic and have a plan upfront. We recommend scheduling regular advisory meetings to review decisions and get proactive guidance for tax implications.
Questions about crypto? Give us a call at (614) 456-7222.