When dealing with crypto assets, many investors assume that they only have to pay taxes when they turn their digital assets into cash. This, however, is a costly misconception. In truth, crypto-to-crypto trades are considered taxable events by the IRS. That being the case, it is important that you understand how and when these transactions are taxed for accurate crypto accounting. In this post, the team at Onchain Accounting will be sharing our expertise and breaking down how and when crypto-to-crypto trades are considered taxable events and what you can do to reduce your tax profile.
Are Crypto-to-Crypto Trades Taxable Events?
Yes, in the US, the Inland Revenue Service (IRS) considers crypto-to-crypto trades as taxable events. The IRS takes the position that swapping one cryptocurrency for another (e.g., BTC for ETH) is selling the first asset for fair market value and subsequently purchasing the second asset.
How Are Crypto-to-Crypto Trades Taxed?
As we’ve mentioned above, crypto-to-crypto trades are considered taxable events. What’s more, crypto assets are classified as property, not currency. That being the case, every time you trade in crypto, it is viewed as dealing with an asset, requiring you to calculate a capital gain or loss with each transaction.
To determine your tax liability, you must first calculate the capital gain (or loss) by subtracting the cost basis from the fair market value of the asset at the time of the trade. If the value of the asset has increased, it’s a capital gain, but if the value has decreased, it’s a capital loss.
The tax rate applicable to the transaction will depend on how long the asset was held. If the asset was held for less than a year, the short-term rate will be applied. However, if the asset was held for longer than a year, the long-term rate will be applied. In most cases, the long-term tax rate is less than the short-term rate.
Common Mistakes Investors Make with Crypto-to-Crypto Trades?
When it comes to dealing with crypto-to-crypto trades, there are several mistakes investors make that can complicate things in terms of compliance and accounting. If you’re looking to avoid these mistakes, you first need to know what they are. Here are some of the most common mistakes investors make with crypto-to-crypto transactions from a crypto accounting standpoint.
- Assuming tax-free status—The first and most common mistake investors make is assuming that crypto-to-crypto transactions are tax-free. As we’ve mentioned, it is not.
- Miscalculating the cost basis—The cost basis plays a crucial role in calculating your tax liability. Miscalculating it can result in your paying more or less tax than you should.
- Missing transaction records—Failing to keep track of your trade history, including small trades and decentralized finance (DeFi) transactions, can lead to incorrect capital gains or losses.
- Improper Reconciliation – Misclassifying internal transfers can lead to double-counting, resulting in incorrect tax calculations.
- Using improper valuation methods—Not using the correct fair market value in fiat currency at the time of the transaction can lead to improper calculations.
How to Properly Track Crypto-to-Crypto Trades
Here are the steps you need to follow to properly track your crypto-to-crypto transactions:
- Record the date & value—Document the date of the transaction, along with other crucial details like the exact time, volume, and fair market value of both assets in your local currency.
- Determine the cost basis—The cost basis is the amount you paid for the crypto, including the transaction fee. Keep track of it to ensure proper capital gains and tax liability calculations.
- Reconcile regularly—Regularly check your wallet activity with your records to identify potential errors, including missing transactions and double counts.
- Maintain a consistent accounting method—Consistently use the same, approved accounting method to track your transactions.
- Track fees – Network fees and exchange trading fees are generally considered deductible expenses. Make sure to separately track them and reduce your taxable gains.
- Working with a cryptocurrency accountant—keeping track of everything by yourself can be difficult. Hand over that responsibility to an experienced accountant and invest with greater confidence.
Conclusion
Crypto-to-crypto trades may not feel like “cashing out,” but the IRS begs to differ. In fact, they consider such transactions taxable events. As such, without proper tracking, it’s easy to lose track of everything and get yourself in hot water with the IRS. That’s why accurate crypto accounting is non-negotiable.
If you’re looking for the best of the best, Onchain Accounting is here to help. At Onchain, we help investors make sense of the complex world of crypto transactions and turn messy data into clean, audit-ready reports that are IRS compliant. Ready to get your crypto taxes in order? Contact Onchain Accounting today and let our experts guide you.
