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Crypto day trading

What is Crypto Day Trading? What are the Tax Implications of Crypto Day Trading?

Crypto day trading is a lucrative activity - before you get started as a day trader, learn everything there is to know about crypto day trading taxes.

Years ago, if you wanted to trade in stocks, you had to approach brokerages, financial institutions, and trading houses. Over the past 25 years, however, the growth of online trading and discount brokerages, coupled with very low commissions have levelled the playing field, or trading field so to speak.

The trading space leapfrogged even further in 2009 when the first cryptocurrency, Bitcoin was launched. Gradually, a lot of altcoins and stable coins were launched making a perfect bedrock for crypto day trading. But, what is crypto day trading? How is it done and what the tax implications of crypto day trading tax? Let’s take on these topics one by one.

What is Crypto Day Trading?

Just like stock day trading where a stock or a security is bought and sold within a single trading day, crypto day trading is the practice of buying and selling cryptocurrencies within a single trading day. It is also called “intraday trading.” Day traders function on events that stir up short-term market moves and one of the popular techniques is news-based trading which includes economic statistics, corporate earnings, and more. Technical analysis is another popular day trading method.

Intraday trading can be a lucrative career but for that, you need well-planned strategies and a ton of experience. This doesn’t mean that novices can’t get started with crypto day trading, they can choose a strategy that suits them best and start small. It is important to remember that even the most seasoned traders can slip up and book losses. They can even miscalculate their day trading crypto taxes as they have hundreds and sometimes thousands of transactions and one might slip through the cracks. A crypto tax software like ZenLedger can help prevent these miscalculations and slip ups.

However, before starting a career in crypto day trading there are a couple of market conditions that you should know about:

  • Liquidity: Traders should enter and exit a trade quickly without affecting the prices too much. In a market with low liquidity, slippage—a large position that can’t be liquidated at the trader’s desired price— could negatively impact the trader’s profits. With slippage, the position has to be sold in increments, with lower profits than the previous one, leading to fewer gains by the time the whole position is sold.  
  • Volatility: If a market is less volatile that means there’s no movement in the price. And since day traders buy and sell during the same day, the market has to go up and down in a short period for them to book a profit. 

Important: Crypto mining can also affect the market as miners sell most of the coins they mined. This can sometimes increase the selling pressure.

Before we dive into the strategies, let’s try and understand crypto day trading and taxes

Tax Implications of Crypto Day Trading

Before you begin day trading in crypto, you must know about the taxes associated with it. As the Internal Revenue Service considers cryptocurrency as property, buying and selling crypto is a taxable event. If you hold a token for more than a year, then the long-term capital gains will be levied on you and if you sell the digital asset within a year of buying it, you have to pay the short-term capital gains tax. Long-term capital gains taxes are taxed at a lower rate while short-term are taxed at a normal rate. The below table might help in better understanding crypto day trading and capital gains tax:

Gross Annual Income Long-Term Cap. Gains (%) Short-Term Cap. Gains (%)
Till $9,325 0 10
$9,326 to $37,950 0 15
$37,951 to $91,900 15 25
$91,901 to $191,650 15 28
$191,651 to $416,700 15 33
$416,701 to $418,400 15 35
$418,401 or more 20 39.6

Other than tax professionals, traders can also take the help of crypto tax software to ease up the calculation of your crypto tax liability. Here’s how you can do it with ZenLedger.

Calculating Your Crypto Taxes with ZenLedger

ZenLedger is a leading cryptocurrency tax platform that has been helping its users save money and be IRS compliant since 2017. With ZenLedger, you can not only create your crypto tax reports but also monitor your asset portfolio. This platform is compatible with LIFO, HIFO, and FIFO reporting methods. It automatically calculates your cost basis, fair value, gains, and losses, and populates your tax forms with the correct data. 

ZenLedger has two types of subscription plans: DIY and Tax-professional assisted. It goes without saying that DIY is the more cost-effective plan as it allows the user a free tier permitting up to 25 transactions. Not to mention, this free plan has most of the features and functionalities of a paid subscription. In the Tax Professional Prepared plans, ZenLedger introduces you to a crypto tax professional for quick and easy crypto and non-crypto tax calculation. 

Crypto Day Trading Strategies

For a long-term strategy, just holding cryptocurrencies has proven to be profitable. Thus, if you are considering a crypto investment, just buying and holding tokens is an excellent strategy. However, investors must remember that cryptocurrencies are highly speculative investments meaning just because their value increased in the past, it doesn’t mean it will continue to increase. 

That said, for intraday traders, there are numerous strategies that they can follow. Here are a few: 

1. High-Frequency Trading (HFT)

In the HFT strategy you benefit from the rapid price changes that occur on the order of seconds or fractions. The frequency of trades in this strategy is in the dozens per second, which is quite impossible for a human trader to keep up with. The only way to use the HFT strategy is to use software known as a trading bot. The bot continuously monitors the market and executes trades based on the given logic, which can be combined with other strategies. 

2. Scalping

Scalping takes advantage of the tiny price moves over short periods, which is often caused by market inefficiencies such as rifts in the bid-ask spread or rifts in liquidity. To amplify their gains, “scalpers” often take advantage of margin or futures contracts. However, it can amplify the losses as well, and therefore it is important to manage risks in this strategy. Scalpers use indicators such as order book analysis, volume heat maps, or a range of technical indicators to enter or exit a position. Since it is highly risky and fast-paced, it is ideal for experienced traders. 

3. Range Trading

This crypto trading strategy is based on the assumption that how much crypto prices will fluctuate within a certain range. If the price moves outside the range then it is assumed that the prices will fluctuate abnormally. For instance, if the price falls below the range’s lower bound, it is an indication to sell as it could be the beginning of a significant downward trend. 

4. Technical Analysis

Technical Analysis or TA leverages start patterns and mathematical indicators to predict the price movement. Some technical indicators are computer generated metrics, such as those on TradingView, while others are manually identified by traders looking at charts. 

One of the most popular technical indicators is the relative strength index (RSI). It appears    under a chart as a single line with a value between 0 to 100. For instance, if the RSI gets closer to 100, it indicates that the token is overbought, which means the prices could fall.  Similarly, if the RSI is closer to zero, it means the token is oversold and prices could rise. 

5. News and Sentiment Analysis

News and Sentiment Analysis which is looking at newscasts and overall market sentiment for crypto day trading. The idea behind this strategy is that oftentimes big headlines can affect the crypto markets and create huge ups or downs. Moreover, a few websites monitor the sentiment behind the most popular cryptocurrencies by evaluating Twitter chatter. If crypto has more positive tweets, it might have a bullish sentiment and vice versa. 

Which Token is Best for Day Trading?

As disappointing as it may sound, zeroing in on a cryptocurrency as the “best” for day trading is almost impossible. It always depends on what happens in the crypto market currently, how you trade, which strategy you use and you can’t forget the crypto day trading taxes that affect your profits. The tax on day trading profits should never be overlooked because no matter how big of a profit you book, at the end of the day, you have to pay the day trading capital gains tax levied on you by the IRS. 

You should also bear in mind that crypto markets are highly volatile. However, some coins can soar in value; Dogecoin for example.  Started as a joke, this meme-based coin skyrocketed from a fraction of a penny to over $0.25 within months i.e, billions of dollars in value. But the prices did come down and it is still considered highly volatile because it is easily mineable and people holding large amounts of Doge can sell them when opportunity strikes. While it creates opportunities for intraday traders, they must remember that crypto day trading and taxes go hand in hand. Before making multiple trades a day they have to consider crypto day trading taxes. 

Trader Tax Status Designation

Assuming you trade for more than 30 hours in a week or execute 4-5 intraday trades per day, you might qualify for Trader Tax Status (TTS). 

This designation provides a lot of opportunities for tax efficiency as professional traders can report their trading liabilities and income as Schedule C business expenses. You can directly benefit from this designation by deducting items like trading and home office expenses. However, this designation is not guaranteed. We recommend checking out the IRS webpage on TTS for more information.

Mark-to-Market Trader

The TTS designation has the ability to deduct losses beyond the capital loss limit of $3,000. A TTS designated trader must make a mark-to-market election on April 15th of the previous tax year. This allows the trader to calculate their entire trading gains and losses as business property on part II of Form 4797. 

Also, it is important to keep in mind that a TTS-designated trader is exempt from the wash sale rule. This accounting principle only cares about the sum of profits and losses of a tax year. But, day traders that choose this accounting method have to pretend to sell all their assets at the current market price on the tax year’s last trading day and pretend to buy back all the assets when the trading restarts in the new tax year. This is only a paper transaction but has to be done to show the total accounting of the business assets every year.

To Summarize

While crypto day trading is a lucrative activity one must be wary about the tax implications of day trading. For one, you have to log all the transactions if you perform multiple trades which can be cumbersome and prone to error. Also, you shouldn’t forget the volatility factor either as interacting with cryptocurrencies this way is highly risky. You must have a working, well-built strategy and a crypto tax calculator like ZenLedger at your disposal to avoid any miscalculations. However, if you still have doubts about filing your taxes, you must consult a certified tax professional.

Day Trading Taxes FAQs

1. Do you have to report crypto on taxes if you don’t sell?

Buying crypto with fiat currency isn’t a taxable event on its own. If you buy and hold cryptocurrency and it increases in value, you don’t have to pay taxes. There has to be a taxable event first which requires selling the cryptocurrency. If you sell within a year, you have to pay short-term capital gains tax and if you sell after a year, you have to pay long-term capital gains tax.

2. Do you get taxed for day trading crypto?

Yes, if you are buying and selling cryptocurrencies on a daily basis then it is a taxable event. The IRS considers cryptocurrencies as property and your virtual currency is taxed the same way as other assets such as gold and stocks.

3. How can I avoid paying taxes on cryptocurrency gains?

If you want to save money on taxes, you can use tax-loss harvesting. Here, you sell your tokens while in a loss position to offset your capital gains. This reduces the taxes on the gains that you’ve made. Even if you don’t have capital gains to offset, this could still be beneficial as capital loss deduction on your income.

4. How does the IRS know if you sell Bitcoin?

The IRS uses different ways to detect crypto transactions even when traders and investors don’t withdraw tokens from their wallets and later convert them into fiat currencies.
For starters, crypto exchanges send Form 1099 to alert the IRS that the taxpayer has been trading cryptocurrency. Moreover, the IRS also uses blockchain analytics tools to find out pseudonymous wallets connected to the actual person.