Successful cryptocurrency trades know that tax season can be a stressful time.
To accurately file your taxes, you’ll need to report every time you sell or trade away your cryptocurrency. This can be especially difficult if you have a high volume of transactions from cryptocurrency trading bots.
In this guide, we’ll discuss everything you need to know about how cryptocurrency trading bots are taxed. We’ll also break down a simple strategy that can help you easily track all of your taxable transactions.
The basics of cryptocurrency taxes
In the United States, cryptocurrency is subject to capital gains and ordinary income tax.
Capital gains tax: When you dispose of cryptocurrency, you’ll incur a capital gain or loss depending on how the price of your crypto has changed since you originally received it. Examples of disposals include selling your cryptocurrency or trading it for another cryptocurrency.
Ordinary income tax: When you earn cryptocurrency, you’ll recognize income based on the fair market value of your crypto at the time you received it. Examples include earning airdrop or staking rewards.
If you’re using cryptocurrency trading bots, it’s likely that you’ll have multiple disposals subject to capital gains tax.
However, it’s important to remember that not every transaction is subject to tax. There’s no tax simply for holding cryptocurrency or moving your crypto between different wallets that you own.
Will I be taxed as a business?
It’s possible that some traders who use trading bots may be taxed as a business.
Remember, you don’t need to have a business entity to fall into this category. You will be required to pay relevant taxes if you meet the IRS’s criteria for being considered a business. These include:
- The time and effort you put into your trading activity
- Whether you keep accurate books and records and manage your trades in a ‘businesslike manner’.
- How much you depend on the income from your trading activity
- Whether your trading activity makes a profit in some years and how much profit you make
If you are classified as a business, your income from your trading activity will be classified as ordinary income and taxed accordingly. In addition, sole proprietors are subject to a self-employment tax of 15.3%.
If you’re not sure whether your trading activity would fall into the business category, reach out to your tax professional.
3 ways to save money on your crypto trading taxes
While there’s no way to legally evade your cryptocurrency taxes, you can use the strategies below to reduce your tax bill on cryptocurrency trading activity.
Harvest your losses
If one or more of your cryptocurrencies are trading at a loss position, you can harvest your loss for tax benefits!
Capital losses can offset all of your capital gains for the year and up to $3,000 of income. Any losses above this amount can be rolled forward into future tax years.
Choose the right accounting method
If you’ve bought the same cryptocurrency at multiple price points, your total capital gain may differ depending on what accounting method you use. To better understand how this works, let’s take a look at an example.
You buy 1 Bitcoin for $10,000.
Months later, you buy 1 Bitcoin for $20,000.
After 2 weeks, you sell 1 Bitcoin for $25,000.
FIFO (first-in first-out) method is considered the default method. With this method, the first coin you acquired is also the first that you dispose of. Using FIFO, your capital gain will be $15,000.
However, you could potentially save money by using the LIFO (last-in first-out) method. In this case, the last coin you acquired is the first you dispose of. Using LIFO, your capital gain will only be $5,000.
Remember, to use a ‘specific identification’ method like LIFO, you’ll need to be able to identify each individual unit of your cryptocurrency holdings. This requires keeping detailed records of your transactions (more on this later).
Deduct relevant expenses
Fees related to acquiring and disposing of your cryptocurrency can reduce your capital gains tax.
Remember, your capital gains and losses are calculated through the following formula.
Capital Gain/Capital Loss = Gross Proceeds – Cost Basis
When you pay fees to acquire cryptocurrency, it can be added to your cost basis. When you pay fees to dispose of cryptocurrency, it can be subtracted from your gross proceeds. In either case, fees will reduce your total capital gain.
How do I track my crypto trades for tax purposes?
To accurately report your cryptocurrency transactions for tax purposes, you’ll need to keep track of the following information.
- The type of cryptocurrency
- The amount of cryptocurrency
- The date you received your cryptocurrency
- The date you disposed of your cryptocurrency
- The fair market value of your cryptocurrency at the time of receipt (in USD)
- The fair market value of your cryptocurrency at the time of disposal (in USD)
- Relevant fees (in USD)
Trying to track this information manually can be difficult, especially if you have a high volume of transactions or you’re trading crypto across multiple wallets and exchanges.
Luckily, crypto tax calculators can help. Platforms like CoinLedger can help you aggregate your transactions across all of your exchanges and wallets and help you generate a comprehensive crypto tax report with the click of a button.