Crypto transactions can make tax time a challenge, especially if you’re new to the world of crypto assets. As the IRS continues to step up its enforcement, it’s essential to remain compliant with tax laws to avoid potential penalties or legal issues. Fortunately, most transactions are relatively straightforward, and new tools can help simplify the process.
Let's look at how to report crypto transactions on your tax return and how tools like ZenLedger can help simplify the process.
#1. Gather Your Transactions
The IRS treats virtual currencies as property subject to capital gains and losses. For each sale, exchange, or disposition, you must compute your profit or loss and then add up these figures to determine the net profit or loss each year. Then, if you have a net profit, you must pay a tax on that amount based on your holding period and marginal tax rate.
If you only use a single crypto exchange, you may receive a Form 1099-B from the exchange that you can use to compute your capital gain or loss. But if you use multiple wallets or exchanges, the Form 1099-B they provide may not be accurate, and you'll need to aggregate every transaction and organize them chronologically to determine a transaction’s cost basis.
For example, if you purchased Bitcoin on one exchange in January and sold it on another exchange in February, the first exchange would have no record of its sale. As a result, they might overstate or omit your capital gain on Form 1099-B.
ZenLedger makes it easy to aggregate transactions across different wallets and exchanges. In addition, the platform pulls historical pricing information for thousands of crypto assets automatically and fills in the cost basis for each transaction. That way, you don’t have to go back and find the trading price of each crypto asset to find the value of a transaction at a specific point in time. And even better, the platform pre-fills the IRS forms you must file each year (discussed below).
#2. List Them On Form 8949
The next step is reporting each crypto sale, exchange, or other disposition on IRS Form 8949, where you compute each transaction's capital gain or loss and add them up.
You may choose between the default first-in, first-out (FIFO) method or the specific identification when determining your cost basis:
- FIFO – The FIFO method assumes you sell crypto assets chronologically, beginning with your earliest purchase. So, for example, if you purchased one Bitcoin in January and one Bitcoin in June and then sold one Bitcoin in December, the cost basis for the sale would be the price you paid in January.
- Specific ID – The specific identification method lets you choose the specific crypto asset you sold. For instance, you can apply a last-in, first-out (LIFO) approach or a highest-in, first-out (HIFO) approach to potentially raise your cost basis and reduce your capital gains. But you must document each transaction on Form 8949.
Start by filling out the information at the top of the form, including your name and Social Security number.
Next, check boxes (a), (b), or (c), depending on if you received a Form 1099-B from a crypto exchange. As of 2022, most crypto exchanges do not provide 1099-B forms, so you'll likely check box (c). However, new regulations will require 1099-B forms in the future, making it easier to complete Form 8949 if you use a single exchange.
Then, list each transaction in the table provided:
- Description of property – Write the asset that you sold, exchanged, or disposed of (e.g., 0.01 BTC). Using the specific ID method, you must also report a transaction identifier.
- Date acquired – Write the day you purchased the crypto asset you're using as the cost basis of the transaction. (e.g., 01/01/2022)
- Date sold or disposed of – Write the day you sold, exchanged, or disposed of the asset. (e.g., 02/01/2022)
- Proceeds – Write the gross USD value of the crypto asset sold, exchanged, or discarded. (e.g., $25.90)
- Cost basis – Write the gross USD value at which you acquired the crypto sold, exchanged, or discarded, including purchases in fiat currency or another cryptocurrency.
- Adjustments, if any, to gain or loss – Most taxpayers don't have any adjustments, but there may be some necessary instances, and you should report them in these columns.
- Gain or (loss) – Write the difference between columns (e) and (d) and then combine the result with column (g) to determine your net capital gain or loss in USD.
And finally, include the totals in the aggregate boxes at the bottom of the form, including the total proceeds, total cost or another basis, total adjustments, and total gain or loss. If you’re using ZenLedger, the platform automatically creates your Form 8949, so you don’t have to manually fill in any values.
#3. Add the Total to Form 1040
The next step is taking the data from Form 8949 and using it to complete Form 1040 Schedule D, where you'll break down short- versus long-term capital gains and compute your net gains or losses. That's because long-term capital gains are subject to lower tax rates (typically 15%) than short-term capital gains (your marginal tax rate).
Then, report the net capital gain or loss on Form 1040 Line 7. If you're carrying losses forward from previous years or want to carry a capital loss forward from the current tax year, you must report it on Schedule D, too. Typically, these losses can help offset any capital gains and up to $3,000 worth of ordinary income each year.
#4. Report Any Crypto Income
Most crypto profits fall under capital gains, but there are some exceptions to the rule. For instance, crypto mining and staking, airdrops, hard forks, and crypto lending could be considered ordinary income. You must report these sources of income on Form 1040 Schedule 1, where they typically fall under Line 8, "Other income."
You also need to report any self-employment crypto income on Form 1040 Schedule C. For example, if you receive crypto as income from a consulting gig, crypto mining, or selling non-fungible tokens (NFTs) as an artist. You can also deduct any expenses from that income, such as crypto mining equipment or design software for NFTs.
#5. File Your Tax Return
Crypto assets are typically just part of the tax preparation process, so you'll need to complete the rest of your Form 1040 and other taxes to finish filing for the year. You may also need to complete additional Form 8949s for stocks, bonds, or other assets. Or, if you have a stake in a crypto business, you may need to report Schedule K-1s.
Of course, it's always a great idea to seek out the advice of a tax professional to ensure that everything is correct – even if you use crypto tax software to generate your tax forms.
The Bottom Line
Completing your crypto taxes can be a complex endeavor if you use multiple wallets and exchanges, generate business income, or use advanced products like decentralized finance (DeFi) platforms. While we've covered the basic steps in this article, you may need to take additional steps for more complex tax cases.
ZenLedger can help simplify your tax preparation by automatically aggregating transactions across wallets and exchanges, computing your capital gain or loss, and pre-filling the IRS forms you must file each year. In addition, you can use the platform’s tax loss harvesting tool to identify ways to save throughout the year by realizing losses.