How to Handle Cryptocurrency Tax Reporting When Trading on Centralized Exchanges

How to Handle Cryptocurrency Tax Reporting When Trading on Centralized Exchanges

Hey there! Dealing with cryptocurrency taxes can be super confusing and overwhelming, I totally get it. I remember when I first started trading crypto on exchanges like Coinbase and Binance – figuring out how to handle the tax reporting side of things seemed like a huge headache. But it doesn’t have to be! In this article, I’ll walk you through the key things you need to know about crypto taxes when using centralized exchanges like Coinbase or Kraken. I’ll try to explain it in simple terms without getting too technical. My goal is to make this as easy as possible for you!

The Basics – Crypto is Taxed as Property

First things first – the IRS treats cryptocurrency as property, not currency. That means that crypto is subject to capital gains taxes. Whenever you sell or trade crypto, you trigger a taxable event. If you sold the crypto for more than you paid for it, you have a capital gain and owe taxes on the gain. If you sold it for less than you paid, you have a capital loss which can offset gains. The capital gains tax rate you pay depends on how long you held the crypto before selling. If you held for over a year, you pay the long-term capital gains rate which is 0%, 15% or 20% depending on your income. If you held for less than a year, you pay short-term capital gains rates which are the same as your ordinary income tax rate (10%, 12%, 22%, 24%, 32%, 35% or 37%).

How Centralized Exchanges Report to the IRS

Many popular centralized crypto exchanges like Coinbase, Gemini, Kraken, and Binance.US are now required to issue 1099 tax forms to the IRS for certain users. This started in 2023 for 2022 transactions. Exchanges have to report transactions for users who meet both of these criteria:

• You have over $20,000 in transactions on the exchange in a year
• You have over 200 transactions on the exchange in a year

If you meet both of those criteria, the exchange will report your transactions to the IRS on Form 1099-B. This form will list out all of your taxable crypto transactions for the year with the capital gain/loss calculated for each transaction. The IRS will then match up the 1099-B they receive from the exchange with the crypto gains/losses you report on your tax return.

How to Calculate Your Crypto Gains and Losses

If you don’t meet the $20,000 and 200 transaction threshold to receive a 1099-B from an exchange, you are still responsible for reporting your crypto gains/losses yourself! The IRS isn’t going to do the work for you. For each taxable crypto transaction you made, you need to calculate your capital gain or loss. Here’s how to do it for a crypto sale:

1. Cost basis = how much you paid for the crypto + any fees
2. Proceeds = how much you sold the crypto for – any fees
3. Capital gain/loss = Proceeds – Cost basis

You’ll need to gather records of your crypto purchases and sales from all the exchanges and wallets you use. Exchanges like Coinbase allow you to download your full transaction history to make this easier. Then you can plug all of this data into crypto tax software like CoinTracker that will calculate your gains and losses for you.

Avoid Double Counting Transactions

One thing to watch out for is double counting crypto transactions. Let’s say you purchase 1 ETH on Coinbase Pro then immediately transfer it to your MetaMask wallet. Later, you transfer that 1 ETH from MetaMask to sell back on Coinbase Pro. You only actually purchased and sold the ETH once, but it will show up as multiple transactions. You don’t want to calculate gain/loss on the transfers in between exchanges and wallets – only for the original buy and final sell. So keep an eye out for duplicate transactions like this when gathering your data.

How Airdrops, Forks, Mining, and Gifts are Taxed

Aside from just buying and selling crypto, there are some other types of transactions that can create tax liabilities:

• Airdrops – Receiving free coins from an airdrop is taxable income. You owe taxes based on the value of the coins at the time you received them.
• Forks – When a blockchain forks into two, you have to report any new coins you receive from the fork. The value gets added to your cost basis.
• Mining – Receiving newly mined coins is taxable income. You owe income tax on the fair market value when mined.
• Gifts – If you gift someone crypto, it is not taxable to you. But if the value has increased since you bought it, the recipient takes over your cost basis and will owe capital gains taxes when they eventually sell.

Tax Loss Harvesting with Crypto

Here’s a cool tax strategy you can use called tax loss harvesting. The basic idea is that you sell crypto at a loss to offset capital gains. For example, say you gained $5,000 from selling ETH but lost $3,000 selling XRP. If you tax loss harvest, that $3,000 XRP loss will offset your $5,000 ETH gain, so you only end up paying taxes on $2,000 total capital gains. This results in tax savings!

You do have to be careful with the wash sale rule though when tax loss harvesting crypto. This rule prevents you from selling crypto at a loss and then immediately buying it back just to harvest the loss. You have to wait at least 31 days before buying back the same crypto otherwise the loss will be disallowed.

Crypto Tax Forms You May Need to File

Alright, you’ve calculated all your crypto capital gains and losses for the year. Now you’ve got to actually report them on your tax return! Here are some of the main IRS forms and schedules you may need to file related to crypto taxes:

• Form 8949 – This is where you summarize your capital gains and losses from crypto and other investments.
• Schedule D – Schedule D aggregates your gains/losses from Form 8949. You’ll total up short-term gains/losses and long-term here.
• Form 1040 – The totals from Schedule D get entered onto your 1040 tax return which is where you calculate how much tax you owe.
• Form 1099-K – If you received over $600 in crypto income from sources like staking, mining, or airdrops, it may be reported on Form 1099-K.

TurboTax, CoinTracker, Koinly, and other crypto tax software can generate all of these forms for you automatically based on your transaction data. Super handy!

Penalties for Not Reporting Crypto Taxes

I’ll wrap this up with a quick warning – it’s absolutely not worth trying to hide or underreport your crypto activity to dodge taxes! The IRS has made it clear that crypto tax evasion is a major focus for enforcement and audits. If you get caught, you’ll face stiff penalties including:

• Up to 5% penalty for underpayment on owed crypto taxes
• 20% penalty for substantial underreporting of income over $5,000
• Up to 75% civil fraud penalty if caught intentionally evading crypto taxes
• Even criminal prosecution is possible in extreme cases!

The penalties and interest charges can end up being way more than the tax you owed. It’s just not worth the risk. File accurately and pay what you owe – it will save you a ton of headaches down the road.

Ok, that covers the key things you need to know about crypto taxes on centralized exchanges! I know it can seem daunting but taking it step-by-step isn’t too bad. Let me know if you have any other questions. Happy trading!