Doing taxes on your crypto gains can be a nightmare.
Because of the volatility of coins, tokens, and NFTs,
tracking your real world capital gains
can get messy pretty quick.
And since crypto is a relatively new
way of investing, many investors will try to
fly under the government's radar.
But I'm here to say a that this isn't the smartest move.
Failing to report your capital gains
from crypto correctly could land you
with significant fines and set you back
far more money than you made in profit.
- I declare bankruptcy!
But I want to make things simpler for you.
This is the best guide on the Internet
on how to account for your crypto.
[Upbeat Music]
because if you get this right,
you may even be able to save money
on your tax obligations.
Now, to start this off, I want to remind you
that I am not a financial advisor.
Always consult with a professional
before doing anything crazy.
Now, I get asked a lot if people really need to
pay taxes on their crypto trades.
The short answer is yes.
The IRS seems to have systems already in place
to gather information from
undisclosed sources about who might have
earned income from investments
in digital currencies.
In 2019, they sent letters to
10,000 individuals letting them know,
"Hey buddy, you may have forgotten to
pay your taxes on your crypto"
and they won't stop there.
With taxes on crypto formalized
in the Infrastructure Investment and Jobs Act,
it's not going to get any more lenient.
The good news is
that there are just a handful of situations
in which you have to include your crypto activities
in your tax report,
and I'm going to cover as many as I can in this
video and give you a free guide as well.
So to keep things simple,
there are three big events
that you should see as taxable.
The first is selling your crypto assets
within one year.
This is because the government sees cryptocurrencies
as property.
Any income you make
in the sale of coins or tokens
is a taxable event.
If you hold onto the coin for over
one year before selling, this is considered
a long term capital gains tax.
What you end up paying depends on the
tax bracket that you fall under.
This chart from Investopedia sums it up pretty nicely.
You'll notice that if you fall under the first pillar,
you'll basically not have to pay
anything on capital gains.
But again, that's only if you're riding your
positions long term, more than one year.
If you're single or you're filing your
taxes as an individual,
you can earn up to $40,400 in gains
without having to pay taxes on those gains.
Also, the limit on tax-free gains
goes up if you're the head of household
or if you file with a spouse.
So there may be some tax advantages
there to getting married.
- What a luxury, you know.
Now, let's compare that with
short term capital gains tax using this
graph from the IRS.
Income on Crypto trading that
comes from selling your holdings that
are less than one year old,
get taxed just like ordinary income.
So right away, looking at this,
2021 federal tax rates actually
start at 10%, even if you earn just
$1 this year.
That's not including tax credits, of course.
And note, the numbers from this chart represent
your total income, not just the income
you made from buying and selling crypto.
If you made that same $50,000 this year
with $10,000 in gains as a single filer
for short term capital gains tax,
you'd pay 22% compared to 15%
if that's long term capital gains.
So it pays to hold long term, if possible.
Another issue comes up when you use your
crypto to pay for goods and services.
This is because spending an asset
like Ethereum or Bitcoin
works the same way tax wise
as selling that asset, unfortunately.
And if you are paid in cryptocurrency
as part of your income or salary,
you'll be taxing this based on the
price of the crypto on the date
in which you were paid.
Meaning if the value goes up
by the time you sell or spend,
unfortunately you have to pay tax
on those gains, and this is at least
until more governments recognize crypto
as actual federal currencies.
If you were paid in crypto or
used crypto to buy things,
you want to keep track of the date, amount
and price of the cryptos when you both
receive them and spend them
for proper tax accounting.
But don't worry later in this video,
I'll have an easier way to keep track of all of that.
The next part is figuring out the taxes
you'd have to pay every time you spend or sell.
This is typically done with the FIFO-
First in, First out method.
Basically, the crypto you receive first
is the first to be considered spent or sold.
Now it is possible to use LIFO-
Last in, First out, to save some tax
but you want to be careful with this and
consult with an accountant
if you want to take that method.
Going back to being paid in crypto.
If you're converting your crypto to cash
on the spot, right when you get paid,
then this is a straightforward as counting up
the amount in US dollars and listing this
in your tax report as ordinary income cash.
There is no conversion.
There's no capital gains on that.
But if you hold your crypto any amount of time
before selling it or spending it,
this is when you need to report that change
in the price of the asset as
unfortunate capital gains.
Now the third category is
exchanging your coins for other crypto.
Some people, many people mistakenly assume
that swapping one crypto for another
is considered a buy and therefore
assume that this isn't a taxable event,
just like buying Bitcoin with US dollars.
But unfortunately, that is not the case.
If you buy Doge with Bitcoin,
you're going to have to pay tax
on your Bitcoin gains.
I know, it's unfortunate.
Remember that crypto is not yet considered
a currency by the US government or most governments,
so they don't see this as a regular buy.
They see this as trading one property for another.
So let's do an example here.
To help guide us, I've created
a Crypto gains & Profit calculator.
Did I spend literally 15 hours
making this calculator work properly
because I thought it would be a good idea for the video?
Unfortunately, yes.
Do you get it for free
without even giving me your email address?
Also, yes.
All I ask is for a subscribe and watch through
to the end of this video.
To the example,
you bought $1,000 in ADA in October.
A month later, you decide
that you really want to buy a Solana Piranha NFT
Who can blame you?
[Laughs] So you go to the pre-launch sale
and find out that 1 NFT costs 1.5 SOL.
To buy this, you're going to go ahead and just exchange
all of that ADA for SOL.
And this is your first taxable event.
Your ADA has gone up from $2.05
when you bought it to $2.30.
According to our calculator, you have a realized gain
of $121.95.
That's the gain that you would have to pay tax on.
And this is because in the eyes of
our tax overlords,
you have sold your ADA and bought SOL.
You need to pay your tax.
Now, here's the crazy part.
You're going to have to repeat that process
again when you exchange your Solana
for your fancy new Piranha NFT.
If your Solana goes up in value significantly,
you should probably track this.
However, to be honest,
you shouldn't consider it the end of the world
if your position shifts a few cents
between that exchange and buying the NFT.
Of course, none of that is financial advice.
Now, the NFT itself
also counts as property,
but as long as you don't sell it within one year,
you don't have to count that appreciation
as ordinary income.
Now something else that is taxable
but free money is using that link in the description
for BlockFi.
With BlockFi, you can earn interest on your
cryptos and get up to $250 in
free Bitcoin by making an account.
But remember to pay your taxes.
Now, what about losses?
If you go through with
any of these activities and you find that
upon some kind of sale or
exchange of your asset, you've incurred a loss
in the value of your crypto, this counts as a capital loss.
It's important to report your losses as well,
because you can actually use this to
offset your taxable income.
Here's an example.
You bought a stock and it increased in value by $500.
Congratulations.
we'll say it's taxed at 10%
or $50 in total tax within the year.
But you also bought and closed a position
on a crypto in the same year that lost $50.
You could write off that $50 tax
by filing the loss alongside
your stock portfolio gains.
Based on IRS guidance, you can actually
write off up to $3,000 in capital losses
if you're filing as an individual.
This can be strategic for you.
It means that you could technically call
your 1st $3,000 in YOLOs per year,
a tax write off.
[Laughs] Not financial advice.
So we've so far covered the basics.
These three examples of taxable events
just about summarize how the IRS
currently views some common transactions in crypto.
But there's still some questions that the government
hasn't answered.
For example, in DeFi,
activities like staking and yield farming
tend to vary in their mechanics
based on the DApp that you use.
This makes it hard to pin down if your
earnings should be taxed like ordinary income,
capital gains or non taxable exchanges of assets.
Now let's break this down.
Your earnings in DeFi are considered
ordinary income when you decide to
use your tokens in order to
receive more tokens.
So take an example of staking Cardano
to earn more ADA,
in exchange for validating transactions.
Because you receive more ADA for
doing this, it works just like our previous example
of getting paid a salary in Bitcoin.
The same applies for mining on a
proof-of-work blockchain.
This is all ordinary income.
Also, if you do have Cardano, you should
consider staking it in my stakepool,
ticker symbol: MAX1.
You'll earn around 5% interest annually
on your ADA and 5% of the revenue
that we make goes to the organization for
Autism Research.
So it's a pretty cool pool.
But it gets a little tricky when you
instead lend your crypto to a lending
platform like Aave or Compound.
These platforms have an additional layer of
complexity because of liquidity pool tokens or LPTs.
When you lend ETH on Compound
to contribute to their liquidity pool,
pool, you get a cETH in exchange,
a sort of receipt for the amount that you invested.
The thing here, is the IRS has not yet
decided whether that counts as an
exchange, and therefore we don't know
whether that's a taxable event.
Breaking this down, your cETH token
may increase in value over time,
and if and when you decide to take
your share of ETH out of the pool,
this then becomes a capital gain.
You need to account for both
the price changes in ETH itself,
and the increase to your ETH stockpile
through lending it because you get
paid back in ETH.
And then you need to indicate in your filing if
your profit or loss is
short term or long term
because that affects how your income is taxed.
If you held your cETH for more than a year,
it could be considered under that
0% tax bracket of capital gains,
so long as you don't hit the other income limts.
Also, a note here, for regular
crypto lending like stablecoin lending,
this is considered ordinary income
on your taxes,
which is a little bit more simple to calculate.
Now, that was one example.
Other DeFi platforms may have different
mechanics on how they work,
different kinds of tokens and different rules.
But when you can enter or exit
a liquidity pool, it's important understand this
before you go into yield farming or
liquidity staking because it can affect your taxes.
Some traders trade across
several exchanges within days,
sometimes facilitated by bots.
Typically, bots are used either for
arbitrage opportunities or
automated trading in crypto.
This is where there's a bit of a grey area.
I've yet to find anything explicitly
in writing how this is taxed.
However, it's safe to assume the worse here
and consider that these gains are
short term capital gains because
the trades happen on a daily basis.
So that would make the most sense.
Now, if you're a professional trader,
you may be able to write off some of your
incurred taxes by citing business expenses
in your tax return.
You can cite utility expenses and
basically any other reasonable expense
that's necessary to run your business,
deduct those expenses from your
total crypto income pre tax,
and then you only get taxed on the remaining profit.
It's a business.
So if a large chunk of your time is going into
regular trading activities,
I would recommend looking at registering yourself
as a business,
but make sure you consult with a
tax professional because this is only going to work
for full-time people who are willing to
pay extra in accounting
and make sure that this is done correctly,
just make sure you do it correctly
if that's an option for you.
Also, if you happen to be someone who
is worried about your crypto tax bill,
I recommend either tracking things manually
just to get your mind off this,
use that free resource in the description if you want,
or you can use an integrated accounting app
like TokenTax or CoinTracker.
These services range in price,
depending on the number of transactions
that you make per year, but it typically
costs you less than about $10 a month.
And another thing that you can get a
ton of value for, for only $10 a month,
is my Patreon.
There you'll find additional content,
my Buy and Sell alerts, that are up
more than $100,000 this year,
a private investor community, coaching,
and a whole lot more.
I look forward to seeing you over there.
So I'd like to thank you so much for watching,
and I hope you have a profitable day!