If you are a regular crypto investor, trader or engage in DeFi protocols, you need to do taxes just like everyone. Unfortunately, due to the volatile nature of the crypto market, there are plenty of variables that you need to account for, making the process complicated and cumbersome.
Thankfully, there are a number of things you can do to make the work easy not only for you, but also for your accountant.
Some of the things you need to do include:
Keep detailed records of your transactions
Many people have the impression that the blockchain is an all-seeing, self-documenting technology.
While in some ways it is, blockchains are not like bank statements, which explicitly record detailed information such as vendor and payee names, or, in some situations, a brief description of the sold item.
Due to this, you can’t ignore bookkeeping on the blockchain.
Blockchains are a permanent record of letters and numbers that you can access via a block explorer, but the data is not user-friendly.
This means that copying and pasting this information into a spreadsheet and sending it to your accountant for cryptocurrency accounting is akin to asking them to solve a “Da Vinci Code” puzzle. Which, as you can tell, won’t cut it.
The best way out is to have a journal for every transaction you engage in. The journal should include:
- Date of trade
- The platform on which you made the trade (e.g., Coinbase, Binance, Uniswap).
- If relevant, include the non-custodial wallet from which you performed the trade, such as a Ledger wallet.
- Which assets did you trade? For example, maybe you traded some Bitcoin (BTC) for some USD Coin (USDC).
- Fees for trading
- It’s also a good idea to keep track of which DeFi protocols you’ve used.
Make a habit of using one exchange.
Using several exchangers causes unnecessary complexity for your accountant throughout the tax season. The more price sources you use, the more complicated things become for your accountant.
This is for two reasons.
First, each exchange generates data in a unique format, increasing the chances of errors when your accountant joins CSVs. Second, this is a very time-consuming, manual task that will increase your billable hours. Everyone loses out in this situation.
Have defined wallets
Good wallet hygiene is important for both expert traders and those that are trying out since it allows accountants to comprehend transactions from a workflow viewpoint as they are processed.
Although it may appear that storing all of your digital assets in one spot is ideal, this is not always the case.
Maintain transaction-specific wallets—such as investments, DeFi transactions, and revenue—and adopt a consistent naming convention.
If you’re a miner, keep a separate wallet for mining rewards. If you create NFTs, have a separate wallet for secondary royalties, and so on.
This will make the work easy for your accountant and, as a consequence, make it cheaper for you.
Involve an accountant as early as possible.
Accounting may quickly become problematic when you have to track activity across many exchanges, blockchains, and wallets and then appropriately report that activity to your accountant.
Talking with your accountant early and regularly can help alleviate this and ensure you’re always on the same page.
As you communicate with your accountant, you should seek to understand their style of accounting.
If you’re filing your crypto taxes for the first time, one of the most important decisions you’ll have to make is whether to use the FIFO, LIFO, or HIFO accounting methods to compute your crypto earnings and losses.
FIFO, or first in, first out, is a method in which you subtract the price of some amount of a crypto asset when you first sold it from the earliest price you purchased for the same amount of crypto asset.
For example, if your first purchase of 0.2 BTC cost $10,000 and you sold it for $15,000, you would owe $5,000 in capital gains tax under this technique.
Using LIFO (last in, first out), you deduct the price of some amount of a cryptocurrency asset when you first sold it from the most recent price you paid for that same amount of cryptocurrency asset.
For example, if your most recent cryptocurrency buy was 0.2 BTC for $10,000 and your first sale of 0.2 BTC was $12,000, you would owe $2,000 in capital gains tax using this technique.
Using HIFO (highest in, first out), you deduct the highest price you purchased for a specific crypto asset from the most recent price at which you sold the same amount of that asset.
For example, if the highest price you paid for 0.2 BTC was $15,000 and you sold it for $10,000, you would record a $5,000 loss on your tax return.
You should discuss with your accountant and agree on the best accounting method to go with.
Bear in mind that in all later years, you must use the same accounting method as you did the first year you reported your crypto taxes. In other words, you cannot apply the FIFO approach one year and the HIFO method the next. You should be consistent.
Automate what you can
We’ve all heard the saying, “The only certainties in life are death and taxes.” However, this is not true for cryptocurrency taxes until regulators provide clarity.
You should work to reduce the amount of uncertainty in this process by automating and streamlining as many of these processes as possible using software.
Fortunately, there are many programs that integrate easily with digital wallets and accounting software—you simply need to choose the one that works best for you.
It gets easier
Your first attempt at crypto taxes can be intimidating, especially if you’ve completed hundreds or even thousands of trades or transactions.
It’s true that learning how to record your cryptocurrency taxes can be difficult at first, but after you get the hang of it, it becomes easier.
Thankfully, by following the above suggestions and working with an experienced tax accountant can make the process feel more manageable and reduce your frustrations.