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September 14, 2020

Crypto Tax Events Professionals Ought To Know: The Swap

(Behind? Check out why the purchase of goods and services are cryptotax -able crypto events in Part 3.)

The (Very) Weird World Of Crypto

Crypto can be swapped for other crypto. This is something the financial world has never seen before. Which brings us to our next cryptotax -able event: the swap.

Imagine for a moment that you purchased some shares in Tesla. You then went and found an exchange where you could swap some of your Tesla holdings for Twitter (i.e. Tesla/Twitter trading pair). You then continued the suspension of your disbelief as you noticed the trading fee was issued in the form of Amazon shares! Well, it's a good thing you’ve been keeping track of fair values and cost basis in U.S. dollars throughout all this, right... Right?! Cryptotax requires it.

And that is just the beginning of the weird and wonderful world of crypto that is unlike anything the financial world has seen before. And, no matter how wonderful for the user, it's creating a world of questions around cryptotax for professionals.

Crypto exchanges can offer many compelling advantages over traditional exchanges such as the Nasdaq or New York Stock Exchange. For example, crypto exchanges are open for trading 24/7 (crypto literally never sleeps), generally offer low and simple fee structures, fractional purchasing for small retail investors, and immediate or at least same-day trade settlement.

Waiting two days for stock to settle once you’ve had a taste of the blazing speed of crypto… Well, stinks. Two business days equates to roughly two weeks in Gen-Z interwebs time. It’s a hard sell. Which is one of the reasons the IRS knows it's here to stay.

Of course, there are also many disadvantages when it comes to startup or early-stage crypto exchanges. Thin order books resulting in slippage, weak internal controls, no standardization in ticker symbols across exchanges, and weak reporting functionality to name a few. But don’t let the details get in the way of a great exchange!

(And, at what point in the cryptotax filing process do professionals "value" the gain or loss?)

Swap, Change & Switch

Swapping one type of crypto for another has been commonplace for a long time in the crypto space. That’s why there is a litany of “crypto swap” exchange providers. ShapeShift, Changelly, and CoinSwitch are some of the most popular ones.

Crypto exchanges in the U.S. in general, have come a long way since the early cowboy “it’s not regulated” days. 

Take Gemini, for example. According to their website, they are SOC 1 Type 1 and SOC 2 Type 1 and Type 2 compliant which was performed by Deloitte. The exchange is a fiduciary and subject to the capital reserve requirements, cybersecurity requirements, and banking compliance standards set forth by the New York State Department of Financial Services (NYSDFS). Also, they offer insurance to cover both online “hot” wallet and offline “cold” storage. Gemini made headlines back in 2018 when they announced they have partnered with Nasdaq to leverage its SMARTS Market Surveillance technology to monitor its marketplace. 

One may argue that these steps towards the institutionalization of crypto should (eventually) get us to better cryptotax reporting for crypto users in the U.S.

So, is swapping one crypto for another considered a taxable event? Yes!

Crypto Taxable Event: The Swap

Nope, you don’t have to cash out to USD fiat currency to trigger a cryptotax -able event.

In terms of cryptotax the exchange one cryptocurrency for another is a taxable event. Swapping one cryptocurrency for another is treated the same way as if you sold for USD and purchased the new crypto with USD.

The challenge for the taxpayer or tax preparer is that many of these exchanges offer very little in the form of reporting. Generally, if you have more than $20,000 in proceeds and 200 transactions during a tax year with a crypto exchange you should receive a 1099-K form. The exchange will also have reported the same to the IRS. The problem is that a 1099-K reports on gross proceeds and not the cost basis and gains and losses derived from your transactions. You know... the actual gains and losses which the IRS requires you to report. 

Some crypto users received a 1099-B which unlike the 1099-K provides taxpayers with information regarding their cost basis (if available) and proceeds from the sale of capital assets. The problem is the “if available” part. It's no easy task for a crypto exchange to track cost basis and therefore will generally not provide a complete 1099-B as it simply does not track the data.

So you can start to see a picture here of just a sliver of the challenges and complexities of financial reporting in the crypto space.

That is where software solutions like Ledgible Tax come in. On the Ledgible Tax platform, the taxpayer or preparer can connect the various crypto exchanges the taxpayer used during the tax year or even bulk upload the transactions from the exchanges and wallets. From there, Ledgible’s powerful SOC certified cryptotax software does all the heavy lifting for you so you can have the peace of mind of filing crypto taxes accurately with a complete audit trail as a backup.

Now let's move on to Part 5 where we'll learn about hard forks and airdrops.

This post is informational only and is not intended as tax or investment advice. For tax or investment advice, please consult a professional.

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