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The Biggest Cryptocurrency Tax Return Filing Mistakes to Avoid IRS Penalties
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The Biggest Cryptocurrency Tax Return Filing Mistakes to Avoid IRS Penalties
Hey there crypto enthusiasts! Tax season is upon us again and I know a lot of you are probably feeling confused or worried about how to handle reporting your crypto activity properly. I totally get it – crypto taxes can be super confusing with all the complex rules and regulations. That’s why I wanted to write this article to help break down the biggest mistakes people make when filing their crypto taxes, so you can avoid extra penalties and audits from the IRS! I’ve been investing in crypto for years now so I’ve seen a lot of friends make these mistakes without realizing it. My goal here is to help you learn from their experiences so you can have peace of mind that your tax return is accurate and compliant with the latest crypto tax laws.
So let’s dive right in! Here are the top mistakes I see people make when filing their crypto taxes:
1. Not reporting crypto activity at all
This is probably the biggest mistake I see – people think if they just don’t report their crypto activity then the IRS won’t know about it. Unfortunately that’s totally false! The IRS has been ramping up efforts to track crypto transactions and they even added a direct question about crypto to the main 1040 tax form. So if you leave your crypto activity off your return, you can bet the IRS will catch that and it’ll likely trigger an audit. Not worth the risk!
The IRS considers crypto an investment property, so you need to report any buys, sells, trades, air drops, mining, staking rewards, and more. It doesn’t matter if you made or lost money – it all needs to be reported. I know some aspects of crypto feel anonymous but the blockchain ledger creates a permanent record of transactions. So do yourself a favor and report all crypto activity to avoid penalties down the road.
2. Not tracking cost basis
When you sell or trade crypto, you owe taxes on the capital gains – which is calculated based on the difference between your cost basis (how much you paid) and the sale price. A lot of people either don’t keep good records of their cost basis or they just estimate it instead of tracking it properly. This can get you in hot water with the IRS if they think you’re under-reporting gains.
My advice is to use a crypto tax software that seamlessly integrates with your wallets and exchanges to auto-track your cost basis. This takes the guess work out of it and gives you an audit trail to show the IRS if needed. If you don’t use tax software, be sure to manually track cost basis for each transaction and save all your purchase receipts.
3. Not harvesting tax losses
Here’s a common mistake that could cause you to over-pay on your crypto taxes. When you sell a crypto for less than you paid for it, you can claim that capital loss to offset taxes on other gains. But a lot of people don’t “harvest” these losses by reporting them – which means you miss out on the tax savings.
Make sure you’re reporting all capital losses on your crypto sales, not just the gains. This will lower your overall taxable income from crypto. You can deduct up to $3,000 in net capital losses each year to offset ordinary income. Any remaining losses carry forward to future tax years.
4. Using FIFO instead of specific identification
Let’s get a bit more technical here. When you sell crypto from a wallet or exchange that contains multiple purchases of the same coin, you have to identify which specific coin lot you sold in order to accurately calculate gains and losses. The IRS default method is FIFO (first-in, first-out) but you can also use specific identification.
The issue with FIFO is it often incorrectly estimates your gains by matching sales to the oldest coins you bought. Using specific ID allows you to match sales to the exact purchase lots you sold. This leads to more accurate gain/loss reporting. So check with your tax pro but in most cases specific ID is the better method.
5. Not filing Form 8949
If you sold crypto in the tax year, you may need to file Form 8949 along with your Schedule D capital gains worksheet. Form 8949 is where you list out each individual crypto sale transaction. This form allows you to provide more details like dates acquired and sold, proceeds, cost basis, and gain/loss for each transaction.
A lot of tax software will automatically generate Form 8949 for your crypto transactions. But if you’re filing manually, don’t forget to include this form if you sold crypto. It provides an itemized breakdown to support the totals you report on your Schedule D.
How to avoid crypto tax penalties
Now that you know some of the most common filing mistakes, here are a few tips to help you prep your crypto taxes accurately and avoid penalties:
- Use crypto tax software to eliminate manual errors
- Keep detailed records of all crypto transactions
- Properly track cost basis for each transaction
- Report all crypto activities – not just gains
- Harvest tax losses to offset capital gains
- Consider using specific ID for cost basis
- File Form 8949 if you sold crypto
- Hire a crypto tax pro if you need help!
I hope this overview gives you a better handle on how to avoid the main mistakes people make when filing their cryptocurrency tax returns. The IRS is cracking down so it’s really important to make sure you get it right. Taking the time to prep accurately now will save you big headaches and penalties later on if you ever get audited. And be sure to consult a qualified crypto tax professional if you need any help tackling your unique tax situation. Happy filing everyone!
References:
[1] https://www.lexology.com/library/detail.aspx?g=8d67746a-39ac-4a80-8caa-e7b5322dc5ac
[2] https://www.accointing.com/en-US/blog/crypto-tax-mistakes
[3] https://ledgible.io/the-top-5-crypto-tax-mistakes-to-avoid/
[5] https://www.levytaxhelp.com/cryptocurrency-filing-mistakes-to-avoid/