Now I know a lot of you readers were already doing that incorrectly, or may not have been worrying about taxes at all. However, as a CPA and active crypto trader myself, I’m interested in helping those who wish to do things in accordance with U.S. Tax law. To be sure, this does not mean I agree with our tax law. In fact, I wish it was much more simple to handle crypto transactions.
Since CryptoCPAs has been in business, we have gotten the common questions of:
“I don’t need to report from foreign exchanges, right?”
“Everything is like-kind, right?”
“There is no need to report my trades, right?”
Several times, these questions feel like uncertainty from the client. They ask for the purposes of having a CPA confirm what they would like to hear. It is not going to happen though, at least not from us. You DO need to report your capital gains from foreign exchanges, alt to alt trades are NOT like-kind, and there is a need to report your trades…even if the IRS may not have much clue with what to do with them quite yet.
Many of our calls are from people who in 2017 had net worth increases in the 6-7 figure range from trading. They’re scared that they may have a large tax liability, which they typically do. Understandably, they want to be compliant with tax law but at the same time, don’t want to spoil their happiness with a large payment to the IRS. I feel the pain. I have several trades in 2017, creating (at least for me) sizeable, short-term capital gains. Here is my biggest problem with the whole thing:
Having a very successful 2017 can lead to a large, out-of-pocket loss in 2018.
Large, short-term capital gains are taxed at ordinary income rates. Successfully trading alts, even if they remain in exchanges or wallets and not changed to fiat, creates taxable income. So, what if Emily, whose short-term capital gains from alt trading reached $200,000, wants to keep trading alts in 2018?
Well, she is at a huge risk. if she averaged a 30% tax rate, she is on the hook for $60,000 as of January 1, 2018. Even if by the time she files her tax return in April her investment is now worth $20,000, she is still on the hook for $60,000 in taxes from 2017. As bullish on crypto as we all may be, the thought of paying $60,000 in taxes on an investment that can go down 90% in 2018 is terrifying. I love crypto, but it can happen. You cannot carryback this hypothetical loss in 2018 to 2017. Instead, you will be able to deduct it against capital gains in future years or take a maximum $3,000 loss per year on future returns if there are no gains to deduct against. As ridiculous as it sounds, that is the way it is.
My favorite solutions to this problem are self-directed Checkbook IRAs and Self-directed Solo 401ks, especially Roth. These are relatively easy and inexpensive to set up. Roth refers to contributions being made with after-tax dollars. They can grow tax free and distributions (at retirement age) are tax free. You can go the traditional route (contributing tax-free, but then paying tax on the eventual distributions), but if you plan on hitting the 5-100xs on your alts over the years, a Roth will be much more beneficial as the growth of your investment will be tax free.
With a self-directed Roth IRA, you managed to contribute $15,000 over the years based on qualifying income. You do pay taxes on this income in the year in which it is earned, but that will be it. You contribute it to a Roth and start hitting the exchanges. At 59.5 years old that amount may be 15,000,000 , which can be distributed tax free.
There are contribution limits to both 401ks (for self-employed individuals depending on income) and IRAs (typically $5,500 per year as of now). Note that if you already have a retirement plan of sorts, you most likely will be able to roll it over to a self-directed Roth one way or another.
“I’m not waiting until I’m 59.5 to spend this money”
Fine. Even with the penalty (10%), early distributions may still result in tax savings. Why? Because you would not have to take all the distribution at once. Let’s take Emily from the prior example, she made $200,000 and owed $60,000 in taxes. If, in 2018, it is her Roth that earns $200,000 instead, there will be no tax. Now, if she wants to start withdrawing from that Roth early, there will be two hits. The first will be the 10% early distribution penalty. This can be avoided with some qualifying purposes, but for the sake of this article we will say it applies. From there, the growth is taxed at her marginal tax rate. So, depending on her other income, Emily can take annual distributions of say, $25,000, and even with the penalty be under $60,000 of total tax paid. More so, Emily did not have to do any complex accounting on the IRA trading.
Is this too good to be true?
No, but you do need to be careful. There are several rules about your self-directed IRA/401k that you must be aware of. Breaking these rules could result in costly penalties, including forfeiture of your IRA. We recommend speaking with an IRA or 401k expert (we will introduce you to one) to really know what you can and cannot do. Depending on the popularity of this with our clients, we may eventually publish a guide.
I’m interested…how much?
It varies. The web is a powerful tool and it may behoove you to do some price shopping if interested. We have contacted multiple providers and are now working exclusively with Sense Financial, as they are professional and move very quickly.
Through Sense Financial (contact info in the next section), the setup will be $1,000 for the 401k and $2,000 for the checkbook IRA. If you mention this article, you will receive $100 off. Also note that through our partnership, tax clients of the CryptoCPAs will be able to receive a larger discount.
Dmitriy Fomichenko, a 401k Expert at Sense Financial says
“Investing using tax-deferred vs. tax-free vehicle (Roth IRA/401) is like planting the crops. Ask yourself “would you rather pay tax on the seeds or on the harvest?” When you use Roth IRA/401k you are paying taxes on the seeds and the harvest is tax-free. And the higher potential returns and the more sense it makes to go the Roth route.”
Traders should consider trading out of a self-directed retirement account if they’d like to simplify their taxes and potentially recognize a lot of tax savings. Though quick to set up, there are rules to be familiar with to avoid severe penalties. Those interested in speaking with our partner may email Dmitriy directly at firstname.lastname@example.org or email us at email@example.com with “IRA” in the subject field. Additionally, for a limited time the CryptoCPAs are still offering complimentary 15-minute consults for potential tax clients. We look forward to hearing from you.
Andrew Perlin, CPA
The Crypto CPAs may receive a commission from Sense Financial.
The Crypto CPAs is the premiere tax accounting firm for cryptocurrency investors and is available to help you strategize and file your tax return. Please see our website, www.cryptocpas.com , to schedule a complimentary 15-minute strategy session.