Crypto assets have grown from a research paper to a multi-trillion-dollar asset class over the past decade. Unfortunately, the crypto ecosystem’s increasing complexity has made tax season a nightmare without the right tools and advice. The good news is that crypto tax software can help simplify and streamline the process.
This article will examine how crypto taxes work and five reasons you should use crypto tax software to simplify the tax prep process.
Crypto Taxes 101
Tax season is stressful for everyone โ even those with the most straightforward returns. But, if doing your taxes is already unpleasant, crypto transactions can turn it into your worst nightmare.
The IRS treats crypto assets as property subject to income and capital gains taxes. While that sounds straightforward, the agency’s unclear guidance, large transaction volumes, and valuation challenges can introduce a lot of complexity. And with the IRS cracking down on crypto, you don’t want to underreport your tax liabilities.
Crypto tax software can simplify calculating and reporting taxes on your cryptocurrency transactions. By importing transactions across wallets and exchanges, these solutions can compute your capital gain or loss and generate the tax forms you need to file. As a result, you can save time, reduce errors, and ensure compliance with tax regulations.
#1. Importing Transactions
The IRS requires taxpayers to complete Form 8949, listing every crypto exchange or sale transaction. But, if you trade crypto across multiple wallets or exchanges, you must consolidate your transactions before filling out the form. That’s because the cost basis depends on when โ and not where โ you bought a crypto asset.
While many exchanges let you export transactions to a spreadsheet, combining transactions across multiple exchanges can be a hassle. For instance, the data may be in different formats, and you must merge the transactions properly to get a chronological list. Furthermore, you must look up the U.S. dollar values for each crypto-to-crypto transaction.
Fortunately, crypto tax software can help streamline the process by automatically integrating with wallets and exchanges. For example, ZenLedger has an API integration with over 400 exchanges, 50 blockchains, and 100 DeFi and NFT protocols. You never have to touch a spreadsheet to get the necessary data.
#2. Collecting DeFi Data
Decentralized Finance, or DeFi, has become a massive part of the crypto ecosystem, providing participants access to crypto loans and enabling investors to generate yield. Unfortunately, the IRS hasn’t provided specific guidance on DeFi tax treatment, leaving taxpayers to apply ambiguous general tax principles.
For example, you may have questions like:
- When you wrap a token (e.g., wBTC) to transfer it across a blockchain, are you taxed on the token exchange?
- If you use a DeFi protocol with rebasing to maintain a consistent value, how are the rebasing events handled from a tax standpoint?
Crypto tax software can help address these challenges by automatically categorizing transactions. For instance, ZenLedger automatically handles lending, borrowing, wrapping, and other DeFi activities, recording taxable transactions and computing your tax obligations. And with support for over 100 DeFi protocols, you don’t have to lift a finger.
#3. Generating Paperwork
Most crypto users must file Form 8949 listing their transactions and carry over the totals to Schedule D on their Form 1040. But, of course, if you generate crypto income from staking, mining, or other activities, you may also need to file Schedule 1 or C to your Form 1040. And in some cases, you may need to file FinCEN 114/FBAR or other forms.
Crypto tax software can help automate the process by generating these forms on your behalf. These capabilities are beneficial if you have a lot of transactions to report on Form 8949. You don’t have to worry about entering data accurately or computing final figures. And, if you use ZenLedger, you can even integrate with TurboTax.
#4. Finding Ways to Save
Benjamin Franklin once said, “nothing is certain but death and taxes.” While you’ll always owe taxes, there are steps you can take to reduce how much taxes you must pay.
Some popular ways to reduce taxes include:
- Long-term Holdings โ The long-term capital gains tax rate is typically lower than the short-term capital gains tax rate, so try to hold positions for more than a year to minimize taxes.
- Accounting Methods โ The accounting method you choose can significantly influence your cost basis and, ultimately, your capital gain on a per-transaction basis.
- Tax Loss Harvesting โ Tax loss harvesting involves selling losing positions to realize the loss and then repurchasing the position in their portfolio, offsetting your capital gains elsewhere.
- Tax-Advantaged Accounts โ Buying and selling crypto assets in an SDIRA can help eliminate or defer taxes.
Crypto tax software can help you take advantage of these techniques. For example, ZenLedger provides a tax loss harvesting tool that shows what crypto assets you could sell to lock in losses and offset your gains. In addition, you can easily compare accounting methods to determine the optimal way to compute your cost basis.
#5. Providing an Audit Trail
Crypto transactions could increase the risk of an audit, particularly if you have other audit-attracting aspects of your return. While the risk of an audit is low on an absolute basis, it’s always a good idea to prepare to defend yourself if the agency comes knocking. And that means having defensible accounting data at your fingertips.
Crypto tax software helps improve record-keeping and makes it easier than ever to create an audit defense. In fact, ZenLedger has a contract with the IRS as a preferred crypto tax software provider, making it a leader in helping both taxpayers and the IRS navigate the complexities of crypto tax filings โ and helping customers sleep better at night!
The Bottom Line
Tax season is stressful for everyone, but crypto assets can be an extra thorn in the side. Fortunately, crypto tax software like ZenLedger can streamline tax filing by automatically aggregating transactions, computing your capital gain or loss, and generating the necessary forms. And you can even find opportunities to save on your year-end tax bill!
