5 Crypto Tax Myths and Mistakes to Avoid

As the April 15 tax deadline approaches, navigating crypto taxes can feel like a minefield. There's a lot to get wrong, and the stakes are high – slip-ups could mean a bigger tax bill or even trouble with fines and jail time. But don't sweat it! We're here to walk you through five common crypto tax mistakes to keep your taxes in check. Whether it's thinking those free tokens are tax-free (spoiler: they're not) or getting your DeFi calculations mixed up, we look at the top 5 mistakes crypto investors make at tax time. 

Thinking airdrops are free money

Imagine the excitement in 2023 when loads of investors found 'free' crypto tokens popping up in their wallets, thanks to airdrops – kind of like surprise gifts from the blockchain world. Remember Arbitrum's big ARB token giveaway? It felt like hitting the jackpot! But here's a friendly heads-up: the IRS sees these airdropped tokens a bit differently – not as freebies, but as taxable income. So, what does this mean for you? When you get these tokens, you need to figure out their value on that very day and, yes, that's the amount you'll be taxed on as income. It's like the IRS is saying, "Congrats on your free tokens, now let's talk taxes." And there's a bit more. When you decide to sell or trade these tokens later, you'll need to navigate through Capital Gains Tax as well. 

Making misguided assumptions about DeFi tax

Let’s start with the obvious - there’s no guidance from the IRS on the tax implications of DeFi transactions. This means a lot of investors (wrongly) assume that there are no tax implications when the truth couldn’t be further from reality. Just because the IRS hasn’t released guidance doesn’t mean there aren’t tax implications for your transactions. The onus is on you as the taxpayer to figure out your tax liability, unfair though it may seem. This is why we always recommend working with an experienced crypto accountant who can help you figure out the best way to tackle your DeFi transactions from a tax perspective. 

Skipping the loaded question

Earlier this year, the IRS issued a reminder to all taxpayers that everyone needs to answer the digital asset question in Form 1040.  The question was revised this year to include rewards, with new wording asking if, “At any time during 2023, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”

This means the only people checking no on this box should be people with no investments in crypto, or crypto investors who have only bought, held, or transferred crypto between their own wallets.

As well as this, the IRS has some undue reporting expectations placed on crypto investors due to the lack of a dedicated crypto reporting form. Currently, investors need to report every single disposal of crypto (so anytime you sold, traded, or spent crypto) alongside your capital gain or loss in Form 8949, and then your net gain/loss in Schedule D. 

In short: 

• Report crypto disposals, capital gains, and losses on: Form Schedule D (1040) and Form 8949.
• Report crypto income on: Form Schedule 1 (1040) or Form Schedule C (1040).
• You can do this with paper forms, or through a tax app like TurboTax or TaxAct.

Misreporting Celsius and other bankruptcy refunds 

Multiple crypto platforms including Celsius, Voyager, and FTX went bankrupt in recent years, and for some of these, investors are finally starting to see refunds. It’s great news, but the tax implications get complicated, fast.

In the instance of Celsius investors, refunds began earlier this year - and whether that impacts your 2023 tax return all depends on the way you want to deal with your potential losses. There’s no guidance from the IRS, so it’s absolutely advisable to speak to an experienced accountant, but in some instances, you may wish to claim an itemized deduction known as a Safe Harbor Ponzi Loss which would impact your 2023 tax return. This all depends on your individual circumstances like filing status, income, and the size of your claim against Celsius, but there are a number of investors who may find this more beneficial from a tax perspective. 

Using a crypto tax calculator tool… incorrectly

Crypto tax calculators can save you hours of manual calculations, spreadsheets, and filling out forms. With the majority of providers, these tools come with default tax settings, based on your location. This means when you import your transaction data, the tool will categorize your transactions in a given way, according to your country’s crypto tax guidance.

But, crypto moves fast, outpacing clear guidance that tax offices, including the IRS need to offer on a variety of transactions. The result? Grey tax areas. While most tools, including Koinly, take a conservative approach to taxation and follow best practices from local experts, these tools also allow users to customize their tax settings. And this is where things can get hairy. When you’re working with an accountant, customizing the default settings can be beneficial. If you don’t know what you’re doing however, your calculations won’t be correct and you may end up filing an incorrect report, paying too much or too little tax, and being audited.

Here are the top user mistakes our support team sees:

• User did not import transactions from all wallets, exchanges, and platforms: Koinly needs your data from all the platforms you use in order to calculate your transactions correctly. Even if you’re just using a cold wallet to store crypto and not making any taxable transactions from that wallet, Koinly still needs the data - so it can distinguish transfers between your own wallets (non-taxable) from disposables to another wallet (taxable).
• User did not import complete transaction history: Even though you’re only filing for a given financial year, Koinly needs your complete transaction history in order to calculate your taxes correctly. This is because Koinly needs to know the cost basis of your crypto, so that if you later dispose of it, it can calculate a gain or loss. For example, if you bought Bitcoin in 2014 and sold it in 2023, without knowing your transaction history from 2014, Koinly won’t be able to calculate your gain from your disposal.
• User did not review imported data: Koinly’s smart, but it can only work with the read-only data that’s imported via API, or that you upload through a CSV file. If there’s data missing, Koinly has an automatic error detection feature that will flag an icon next to your wallet to let you know there’s data missing from your calculations. Koinly isn’t in control of how much data a given API or CSV file imports, so in some instances, these errors are unavoidable. Fortunately, they’re also easily resolved, thanks to a bunch of help guides Koinly offers to walk you through common data import issues.

About Koinly

Founded in 2018, Koinly is a cryptocurrency calculator used by over 1 million crypto investors in over 20 countries. Koinly integrates with 850+ exchanges, blockchains, and wallets to give investors an easy and accurate way to track their crypto transactions in one place. From here, Koinly calculates the total capital gains and income an investor has derived from their crypto in any financial year. 

https://koinly.io/