In this episode, Shehan Chandrasekara, head of strategy at CoinTracker, and Dan Hannum COO at Zen Ledger, take a deep dive into the world of crypto taxes. Over an hour and fifteen minutes they tackle a bevy of topics ranging from why the IRS is asking about your crypto history to explaining the proper way of reporting yield farming income. Shehan and Dan give up their hard-earned tax secrets and tips learned through building their respective cutting-edge crypto tax software. Here is a list of talking points covered in the discussion:

  • how the IRS is handling crypto this year (1:20)
  • where to start with reporting crypto and what constitutes a taxable event (5:59)
  • bitcoin corner cases:
    • mining, with a description of calculating cost basis (19:48) 
    • wages (27:01)
    • peer-to-peer transactions outside of exchanges (28:23)
  • defi and taxes:
    • yield farming — and how it’s like Russian nesting dolls (31:45)
    • how the IRS taxes earned interest (36:32)
    • airdrops (40:15)
  • crypto transactions that are not taxable: purchases, withdrawals, and stablecoins (46:28)
  • navigating tax documents (51:24-58-10)
  • NFT’s and social tokens (57:14)
  • tax loss harvesting (1:03:09)
  • how having coins on platforms like Robinhood and Paypal can have an effect on your taxes (1:05:05)
  • proposed tax changes (1:06:50)
  • crypto tax software and tips for the upcoming year (1:10:29)

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Episode links: 

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Crypto tax guides

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Transcript:

Laura Shin:

Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I’m your host, Laura Shin, a journalist with over two decades of experience. I started covering crypto five years ago and as a senior editor at Forbes was the first mainstream media reporter to cover cryptocurrency full-time. Subscribe to Unchained on YouTube where you can watch the videos of me and my guests. Go to YouTube.com/C/unchainedpodcast and subscribe today. 

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Laura Shin:

Today’s topic is 2020 crypto taxes. Here to discuss are Shehan Chandrasekera, a CPA and head of strategy at CoinTracker. And Dan Hannum, COO of Zen Ledger. Welcome, Shehan and Dan. 

Shehan Chandrasekera:

Thanks for having us. 

Laura Shin:

Just a quick disclaimer. Before we dive in, while we hope that the show is informative for everyone, this is not financial advice and everyone who has any crypto holdings should seek their own personalized tax advice. Also, we need to make one caveat, which is that this show will primarily be helpful for US taxpayers. All right. So, there are some changes to the ways the IRS is handling crypto this year. What are those changes and what does that signify?

Dan Hannum

Yeah. Happy to start with one of them. I guess we can go back and forth a little bit. 

Laura Shin:

Yeah. And this is Dan, for people listening on audio. Go ahead, Dan. 

Dan Hannum

Thanks, Laura. Yeah. I think one of the biggest ones that we saw was towards the end of December with the IRS. I released a new draft for the 1040 question, which is a question that came on for last year but was on the schedule one and now it’s moved to the top of the 1040 so a little bit more prominent placing. 

Laura Shin:

Which is sort of like the front page of your taxes. 

Dan Hannum

Absolutely. Pretty much, yeah. So, the Schedule 1 is a form that not every American needs to file but this 1040 is typically a form that if not everyone, the majority of US-based investors would need to file. Now that question is listed as the number one question and some of the draft guidance that came out I think clarifies a few of the issues mainly around if purchasing crypto you have to check off yes. Under the new draft you now have to check off yes under that question if you’ve purchased crypto, which is a little bit of an interesting conundrum in the sense that purchasing crypto is not necessarily a taxable event, but I think that’s a big major change that we’ve seen to the newest draft and then to the movement of the question itself. 

Laura Shin:

Shehan, do you want to add to that?

Shehan Chandrasekera:

Yeah. Dan, you’re right. In the draft instructions, it did say that if you had purchased crypto you would still have to check yes, but actually I checked out the instructions yesterday and they had removed that language. 

Dan Hannum

Interesting. 

Shehan Chandrasekera:

Yeah. It was interesting to me as well. So, if you look at the instructions right now it does not explicitly say that you need to check yes if you purchased crypto. However, if you purchased crypto, I think it will still be recognized under the received category because it’s such a broad question. But yeah, I mean there was a purchase, that bucket they removed it from the final instructions. 

Laura Shin:

Wait, so now the final does not ask you if you purchased crypto?

Shehan Chandrasekera:

It does not explicitly say that you need to check yes if you purchased crypto, but in the question did you receive any cryptocurrency, so I assume if you’re purchasing something you’re receiving so just to be safe I would check yes. Yeah. 

Laura Shin:

Okay. So, what do those moves mean to you that now it’s right on the 1040, it’s the first question, and they’re even asking if you’ve received crypto, which isn’t necessarily a taxable event? What do those changes mean to you?

Shehan Chandrasekera:

Yeah. I think a lot of people think if I answer this question I’m going to get audited tomorrow. I mean that’s not the case. Right now, the IRS is trying to get a good set of data among US taxpayers with some type of affiliation with crypto because right now they don’t have this data. So, by putting that question on page one they’re going to expose this question and the subject to roughly 150 million taxpayers and you’re supposed to answer this question. You’ve got to say either yes or no and your answer is going to be tied to your Social Security number, etcetera. I think what the IRS is trying to do is they know that exchanges and everybody has seen a tremendous amount of growth because of the recent bull run and the previous bull runs. But the number of returns that they get with crypto has been in thousands. So, it just doesn’t make any sense so that’s why I think they’re trying to get that information. 

Gathering information doesn’t necessarily mean that you’ve got to pay a tax bill. For example, like you said, Laura, if you received a cryptocurrency gift or something like that there’s nothing to report but you would still check yes. There could be another situation where you could be purchasing crypto. The safe thing to do is to kind of check yes but again, there’s no taxable event. But by answering that question, I mean whether you like it or not you have to give that information to the IRS and I’m sure that’s going to go into some type of database and the IRS is going to run some analysis in the future to do analysis among the taxpayers with crypto affiliations, if they’re filing everything correctly or not. 

Laura Shin:

Okay. Wow. All right. So, now we know this is important. So, it sounds like not everybody who should have been reporting has been in recent years, so we might have some long-time crypto people who are just trying to wrap their heads around this for the first time. So, what is the main principle that people should keep in mind when it comes to their crypto and taxes?

Shehan Chandrasekera:

I guess I’ll start. Maybe Dan can add to that later. I think a lot of people don’t realize that crypto is regulated and it’s taxable. Some people, they find out that it’s taxable when they first see the question on turbo tax or when their tax practitioner asks them. So, that’s something to know. Crypto is taxable as a property. If you make any profits you’ve got to pay capital gains taxes and if it’s a loss then actually you can write it off and you could even get a refund. So, reporting your crypto transaction is not necessarily bad because if the market is down you could actually benefit. 

So, the IRS first came out with these rules in 2014. Pretty much said crypto is treated as property. So, from 2014 to 2020, we haven’t seen any major differences in the way that we create crypto even though the crypto space has grown tremendously. We have DeFi, stablecoins, and etcetera. But unfortunately, according to the IRS all cryptocurrency should be treated as property, and that forces some other challenges but we just got to go with what we have right now. 

Laura Shin:

When you say property and you said that means it’s taxed like a stock, so that’s kind of you can have either long-term capital gains tax or short-term capital gains tax and that type of thing. Is that kind of…

Shehan Chandrasekera:

Correct. I think that’s an easy way for beginners to think about crypto taxes. It’s literally like stocks. There are some exceptions but just to kind of give you an idea, you have your purchase price, which we call, in technical terms, a cost basis and then you have a sales price. If there’s a difference and if it’s a positive difference you have a gain and that gain is subject to either long-term capital gains or short-term capital gains. The long-term capital gains occur when you sell your coin after holding it for more than 12 months and then short-term capital gains occur if you sell your coin after holding it for less than 12 months. So, it’s pretty similar to stocks but there’s one exception. For crypto, the wash sale rule does not apply because wash sale rule is only applicable with stocks and securities under section 1091. But kind of thinking about stocks is kind of an easier way to approach crypto taxes in general. 

Laura Shin:

Just to flesh that out for people. When you say the wash sale rule does not apply that means if they were to buy back the cryptocurrency after selling it within some time period…so typically for stocks that wouldn’t trigger a taxable event but it does for crypto, is that what you’re saying?

Shehan Chandrasekera:

So the wash sale rule means that let’s say a stock goes down in value and then you are selling it and you’re buying it back. If you do the buy back within 30 days after you sell it that loss is going to get disallowed by the IRS because the idea is that the IRS doesn’t want you to give any credit for payable losses. But that’s only applicable to stocks and securities. In the crypto world that’s not applicable. So, what that means is if you have your positions in the red, meaning your cost base is higher than your market value, you can sell them, harvest your losses and quickly get back into the same position without having to wait that 30-day wash sale period. So, it kind of allows you to aggressively harvest your tax losses compared to stocks. So, that’s actually one advantage and I don’t see people talking about it. They always focus on the bad side. Why do we have to pay taxes? But if you plan things correctly there are some unique advantages if you deal with crypto. 

Laura Shin:

Okay. Great. So, in general, what information should people be recording in order to be able to report correctly for their taxes? 

Dan Hannum

I mean I think a big kind of misnomer is that you need to be tracking every single transaction and you need to be tracking your cost basis yourself. So, I think one thing like Zen Ledger and like a CoinTracker provides is software that’s able to do that for you. So, one thing that we typically recommend for our customers or our clients is to really track the sources. So, for example, I’m using a Coinbase, a Kraken, a Gemini. I’m using a Ledger, a Trezor, a MetaMask. So, really by tracking what wallet addresses are using, what exchange accounts are using, platforms like the ones that we both provide allow you to simply integrate API keys, integrate CSVs, integrate wallet addresses and then our software actually kind of does all of the in between for you of calculating the cost basis, calculating your gains, your losses. So, what we typically recommend is just making sure that you’re keeping track of what you are using. You don’t have to have an Excel spreadsheet or a Google document or handwritten notes of every single trade or every single transactions but just making sure that you understand the sources that you’re using and then making sure that you’re preferably using a crypto tax software because we definitely believe that it makes your life a little bit easier and makes it really simple to get your obligations taken care of. 

Shehan Chandrasekera:

Just to kind of give some context to people who are completely new to this. If you’re going to trade your stocks and securities in TD Ameritrade or JP Morgan, at the end of the year you’re going to get this form called 1099-B listing cost basis, your market value and the gains and losses. Now, after you get that it’s just a matter of plugging those numbers into your tax return then you are fine. But in the crypto world it does not happen because of the complexities associated with cost basis, etcetera. So, that’s where these crypto tax software tools come in handy so you can connect your exchanges and wallets and those software can provide that cost basis and market value and gains and losses. Then you can include that on the return. Without this software, if you are using multiple exchanges and wallets its virtually impossible for you to kind of track those things and sometimes you could even be overpaying taxes for no reason. So, highly recommend using any of these softwares. 

Laura Shin:

Actually, I just wanted to go back to that question about…the very first question on the 1040 right now is about crypto. I was wondering, what is the penalty for someone if they either accidentally or even dishonestly report that they didn’t have any such crypto transactions or didn’t receive crypto during that year when in fact they did?

Shehan Chandrasekera:

I mean there’s no major penalty. It’s just an informational question but when you sign the return you’re signing the return under penalty of perjury, so you are expected to report things correctly. If you’re intentionally lying on that question that could even be considered fraud. So, to give you an answer there’s no monetary penalty and if you get it wrong you’re going to get penalized for hundred bucks or a thousand bucks. You’ve got to get the question right. Again, that question, a lot of people are scared of that question. I wouldn’t be scared of that. It’s just an informational question and just answer it correctly and if it’s a yes then the second question that you should be asking yourself is – do I have a taxable event or do I have other forms to file?

Laura Shin:

Then one other thing I was also curious about is – there are all kinds of airdrops but there are people who are a bit active in crypto and then later are not active and whatever. If they come in during some kind of bubble and then they drop out when things are a bit quieter. So, if they receive an airdrop but they don’t know that they’ve received it and they don’t report that, I mean I guess you said there isn’t a penalty but it just feels like there could be a lot of instances where that would happen, right?

Shehan Chandrasekera:

Yeah. I think there could be instances. I mean if you really forget to kind of look at your wallet to see if you receive any airdrop, I would say that’s an innocent mistake. You’re not trying to intentionally defraud the government. Again, that’s another situation where some of these crypto tax software do come in handy because if you are using one of them you can see the taxes at the end of the year and you’re like, Oh I got an airdrop and luckily this software captured it. Now you know you have tax liability and now you know you’ve got to answer that question correctly. 

Laura Shin:

All right. So, let’s now just walk through all the basic different types of transactions that can happen that can trigger taxable events. Let’s talk about what information you might want or need to record or what different factors in the transaction could affect what your taxes might be. So, let’s just start with a basic one. Someone buys crypto and then later they sell it. Walk me through what that looks like for them in terms of taxes. 

Dan Hannum

Yeah. I mean I think Shehan had mentioned it earlier just in the sense that once you purchase that currency then you’ll have that cost basis moving forward. So, depending on how long you held that currency, as was mentioned. If it’s under 12 months, that’ll be a short-term capital gain. Over 12 months, long-term capital gain…one big factor is how long did you hold and then obviously did that actually go up or down before you sold it or traded it. I think that’s another element that we’ll get into later of buying with dollars into fiat, crypto into crypto and then crypto back into fiat are kind of the three main buckets. So, anytime you go from one crypto to another that would be a taxable event and that would come with another set of cost basis, another set of gains and losses. 

But yeah, so the purchase question kind of just depends because I think a lot of individuals may not realize that purchasing crypto with another crypto is not actually a purchase but a trade. It comes with another set of obligations. That comes separate than if you were just using dollars to purchase crypto. So there is kind of, not gray area, but there’s some more context depending on how you purchase that. But typically from dollars into crypto there’ll be no taxable event on that and then depending on how long you held that crypto, under 12 months, over 12 months and then at the end if you sold that back in for another crypto or exited back into fiat. Not only the amount that you held, the gains, losses but then typically some of your own personal information could be included in that as well as far as your own tax rates and things like that. So, there is some complexity to that question and some variables that kind of go into the overall purchase or sale of a crypto asset. 

Shehan Chandrasekera:

Yeah. I guess just to kind of give everybody a summary, again, for those of you who are brand new. Remember these five situations. These are the five situations where you could owe some type of crypto taxes. So, number one, as Dan mentioned, you’re pretty much cashing out. You’ve got a Bitcoin for 10 thousand, you’re selling it for 30 thousand, you’ve got to pay taxes on 20 grand. That’s pretty easy. Number two, when you go from one crypto currency to another, you’re spending Ethereum to buy Bitcoin. In that case, this is a situation that a lot of people don’t get because they’re like I didn’t receive any cash. Why do I have to pay taxes? Unfortunately, the IRS doesn’t care whether you received cash or not, as long as you have access to some type of wealth by moving from one coin to another you’ve got to pay taxes. So, that’s the second situation. Number three is when you earn crypto. You could be earning crypto through wages by working with somebody. It could be interest, it could be DeFi income, mining income, staking income. So, those are taxable events. Number four is when you spend crypto to buy goods and services. There’s a bunch of crypto debits and credit cards. Some people think, Oh I’m just spending crypto. It’s not taxable. It is taxable. So it’s something to keep in mind. Lastly, air drops and forks. In 2020, a couple of major air drops. The UNI airdrops and the Spark airdrops. So, those are the situations where you have some coin but you don’t necessary have cash to pay the taxes. So, you’ve got to make sure you withhold enough taxes or at least after you get the airdrop you convert a portion of that air drop to a stablecoin. So, at the end of the year you’ve got enough cash in hand to pay the taxes. So, those are the five situations I would remember. 

Laura Shin:

Oh, wow. Okay. That’s a smart tip. One thing that I wanted to ask also, so in that case where you are purchasing with bitcoin or cryptocurrency, what if you’ve acquired the cryptocurrency at different times and then you kind of make a big purchase of something like let’s say it’s like you received 20 dollars of bitcoin at one time and then 100 dollars another time and 50 dollars another time and then you buy a plane ticket that’s more than…let’s say it’s close to 200 and you still have other bitcoin. Then how do you determine the cost basis. 

Shehan Chandrasekera:

Yeah. This is where tools like Zen Ledger and CoinTracker come in handy. So, IRS is saying that if you can specifically identify the unit that you deem to be selling, meaning if you have all of the detail records of every crypto currency that you’ve purchased with the date, with the unique identifier and everything, for tax purposes you can pick and choose which unit that you are selling. So, in your example, ideally you want to be dispersing the coin which you paid the highest amount for, thereby releasing your gains. So, you can achieve the specific ID if you’re using a crypto tax tool because if you’re using a tool you automatically keep all those records, but if you don’t use a tool it’s your responsibility to track them on an Excel spreadsheet or something in case you get audited, you’ve got to prove the cost basis for that specific transaction.

Laura Shin:

All right. Okay. Let’s walk through a few other scenarios. So what about people who mine cryptocurrency? What do they need to do to report their taxes correctly?

Dan Hannum

Yeah. Happy to chime in. I think it really just depends on how that mined currency is received from a corporation or an individual. So, if you have an LLC setup and you’re having a mining facility run through a business or a business entity, it’s a little bit different than having an individual. So, that’s kind of a big difference. But at the end of the day, that mining income would be considered as taxable income for crypto tax purposes. So, pretty much the same thing from what we’ve discussed earlier when you receive either that distribution from a pool that you may be operating with or from maybe by luck you were able to get your own block and get your own block reward. That access and that transaction would be viewable on the blockchain. You’d be able to see the timestamp, when it came in, the value that it’s worth in USD value and then treating that income would be just as taxable income. A lot of the times that we see whether it’s individuals or corporations, a lot of that mining income or mining revenue is then used to fund future business operations. So, if you’re converting that income back into dollars or are using that income to then purchase a new Antminer or a new facility or things like that then being able to track that is interesting as well. So, I think we’ve seen that if you’re mining cryptocurrency a lot of the times it’s better to even just setup a simple LLC and have that income come through the business versus a singular entity because you have a little bit different tax rate as a corporation versus an individual. Shehan, I don’t know if you had anything to add on that. 

Shehan Chandrasekera:

Yeah. I think that distinction is super important. Like how you’re going about doing the mining operation because you could be mining as a hobbyist, meaning you could have a couple of mining machines in your basement versus you could take investors’ money and just mining as a business. If you’re mining as a hobbyist you’ve got to pick up the income, as Dan mentioned, the income is the market value every time you get those bitcoin or whatever the coin that you’re mining. You would sum it up on an annual basis that would be your income. If you’re a hobbyist, unfortunately, you cannot deduct your mining-related business expenses because it’s considered a hobby under the IRS. Now, a second option is you’re mining as a business. If that’s the case, you pick up the income, you get to write off all the mining operation related expenses like rent, utilities, subscriptions, and also equipment because these equipments, as you guys know, they’re pretty expensive and luckily the IRS code allows you to depreciate up one million dollars’ worth of equipment under section 179 and there’s bonus depreciation and there’s minimum safe harbor rules meaning if you have receipts and if something is below 25 hundred bucks you can just write off. They don’t even ask what it is for. So, it’s very beneficial. Whenever you earn income by leveraging equipment or like a capital intensive type of business, IRS has very favorable tax rules. So, yeah, I mean talk to a tax advisor about kind of structuring it. But the TLDR here is that if you properly run a mining, especially a proof of work mining business, you’re actually making money but you’re not paying any taxes because you get the deduction from the depreciation which is a non-cash outflow. So, it’s pretty beneficial if you do it right. 

Laura Shin:

One other thing is so Dan kind of very quickly was just like when you mine it you can get the price from any block explorer. So, is that just how you determine the cost basis? Because as we know, the price of let’s say it’s bitcoin can vary depending on what country you’re in. I mean of course I know we’re talking about the US but still even recently there was kind of this question of what was the high that bitcoin reached back in the 2017 bubble. It turned out if you look at Coinmarketcap, because that’s using sort of a global reference, it’s higher than US exchanges. So, yeah, just for a miner then would they have to kind of try to pick a US price, you know what I mean?

Dan Hannum

Yeah. For us, we run full nodes as well, so I think that gives you a little bit more granular detail than using a block explorer like Blockchain.com or Bitcoin.com or Block Explorer. So, running a full node allows you to essentially look at the exact time stamp, look at the exact cost basis. As you mentioned, even finding that USD value can vary depending on if it’s listed on a Coinbase, Binance, a Kraken. I think you’ve covered it in some of your previous podcasts. Some arbitrage opportunities back in ’15 and ’16 where US bases would buy a US exchange and then sell in Asia and get the arbitrage opportunity between the two listed prices. So, we’ve definitely seen that the price is not always consistent and it really just depends on kind of what you’re using. We use multiple price feeds. We run full nodes. So, we have kind of a different ability than I’d say an individual. I imagine CoinTracker is using the same types of technology. So, I think as an individual it’s a little bit harder to figure out exactly what cost basis and what USD value you should use. But by running a full node it gives you a little bit more granularity than just using a Block Explorer, for example. 

Shehan Chandrasekera:

Yeah. I mean running a full node is a great option and all the crypto tax software, they rely on these pricing data providers. So, what these data providers do is they combine pricing from various sources and they kind of clean up those bad actors and bad prices. We rely on the market value coming from those pricing data providers as well in conjunction with running your own nodes and directly getting the price feeds from the exchanges. 

Laura Shin:

Just so I’m clear, so on a node it’s not like you’re going to get a USD price. It’s more than you will know the exact moment of time, is that what it is? Then you can use that against the index, is that what you’re saying?

Dan Hannum

Pretty much. For a node it just gives you a little bit more granularity into the timestamp, into the amount, into the fees that were paid and things like that. You can still find that in a block explorer as well. If you entered in the transaction hash or the address. So, it’s not like it gives you completely different information. Just a little bit more granular detail. But as Shehan mentioned, typically using a pricing aggregator, I mean in my opinion, I think CoinGecko has kind of taken that top spot versus the CoinMarketCap, especially recently especially after the acquisition. We’ve seen some gamifying of the data with CoinMarketCap in the last year or so. But I think CoinGecko has been a very trusted resource that we’ve seen. We’ll leave that out for now but CoinMarketCap and CoinGecko are probably the two biggest ones. 

Laura Shin:

Sounds like a story. 

Dan Hannum

There might be. But CoinGecko is one that we think has done a really great job, as Shehan said pricing out or aggregating some of these additional price feeds, cleaning up the prices and giving you kind of one universal price that you can use across most of exchanges. 

Laura Shin:

Okay. Then earlier we did reference if you earn crypto. So, let’s say some employer does pay you in crypto. Then how would that be taxed?

Shehan Chandrasekera:

Yeah. So, there’s two levels of taxation. There’s taxes that the employer has to take care of and there’s another level of taxation of the employee. For the employer, you’ve got to pay your typical payroll taxes, etcetera. So, that’s a whole other administrative burden on them, but there are major companies like Coinbase and if you like to do so, you can get paid in crypto so that’s pretty common. So, that’s the employer side of things. As an employee, if it’s properly included on your W2 or 1099 and in USD, that’s pretty easy. You just kind of plug that into the return and you’re fine. But in most cases, employers in this case are not super educated. They’re still new and they’re startups. Sometimes they just kind of send out like, hey, here’s some bitcoins as your compensation. In that case, it becomes employee or the contractor’s responsibility to have detailed records of every time you receive those coins, the value of those coins, and you’ve got to sum it up and that should go on your taxes. So again, that another situation where this crypto tax software could come in handy because as soon as you enter timestamp it can convert the coins into USD and it shows you what needs to be included on the tax return. 

Laura Shin:

All right. Then I mean I know this isn’t super common but it does happen. What about peer to peer transactions that don’t involve an exchange, something kind of like a LocalBitcoins or Paxful. How do you handle that? 

Dan Hannum

For us specifically, it’s a little bit trickier than using a Coinbase or a Binance where you have an API key or a CSV set, but one of the things that we offer and I believe CoinTracker does as well is the ability to have a custom CSV or a manual entry where you can actually manually enter in the specific dataset. So, if you’re using a Bisq or a LocalBitcoins or another provider that’s more peer to peer, there’s still an additional element of having to track that yourself and then enter that in. That’s kind of how we are looking at it right now. Because of the nature of the…I know sometimes the exchange is not even the best word or decentralized exchange or for Bisq for example there’s not really a company behind it. So, it gets a little tricky because there’s not a customer support person or a tech team that will be able to provide you a transaction detail. So, it just becomes a little bit more tricky for the average investor. But at the same time, to be fully transparent, the average investor in crypto, in my opinion is not really using those services yet. They’re typically going with a Coinbase, a Kraken if they’re US, a Gemini, one of those US-based exchanges that have a fiat on-ramp. That’s another differentiator I think as well is most of these peer-to-peer exchanges don’t give you the ability to go from dollars into crypto. They’re normally crypto-to-crypto. So, you still have to use another fiat on-ramp to gain crypto. Let’s say, 100 dollars into bitcoin, bitcoin into your Bisq account, bitcoin into whatever asset type you like. So typically, that’s another distinction is with a Bisq or a LocalBitcoins you’re not able to put dollars in and then trade with them. You’re having to deposit crypto in then use that crypto. So, there is a little bit more advancedness, I guess, to using those platforms where the average new user, and I could be absolutely wrong. But the average new user is typically looking for a fiat onramp. They’re looking for someone that can help custody and hold their coins for them and those centralized providers really provide that in an easy to use, most of the time in a mobile app. So, I guess that’s my perspective. But if you’re using those, we and I believe CoinTracker does as well, still gives you the opportunity to manually enter those by singular or putting them into a CSV and then adding a complete CSV file in. So, you can still account for that. It just adds an extra step or two. 

Laura Shin:

All right. So, in a moment, we’re going to talk about some of the more obscure types of crypto transactions that may actually really appeal to my audience such as yield farming and staking and validating and earning interest in all kinds of stuff. But first, we’re going to have a quick word from the sponsors who make the show possible. 

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Laura Shin:

Back to our conversation with Dan Hannum and Shehan Chandrasekera. All right. So, let’s walk through some of these more obscure crypto events. Let’s start with yield farming because that was quite the craze this last year. I’m sure this is going to make a lot of people’s taxes a bit more complex this year. What information do they need and how do they determine cost basis, etcetera?

Shehan Chandrasekera:

Yeah. I would say it’s a mess. There’s so many layers of taxation for a typical yield farming. To have a transaction, so for those of you who don’t know, typically what happens is you some type of coin in an ERC-20 type of environment and then you earn some type of governance token and then you lend the governance token again on another platform and you can just do it on multiple layers. 

Laura Shin:

It’s like Russian nesting dolls or something. 

Shehan Chandrasekera:

Yeah. And on the top of that there are other platforms who kind of help you optimize your entire strategy. So again, it’s a tax nightmare. Again, luckily there are tools that kind of help you figure out those interest income, the P&L based type of accounting meaning you have an entry price and exit price and the difference is the P&L the profit or loss and then you pay taxes on that. So, again it’s an emerging area. IRS probably doesn’t even know that this exists but again we had started work on what we have from 2014. So, it’s challenging but there’s enough guidance there to infer the right tax implications for those transactions. 

Laura Shin:

Which is what? For instance, with the SushiSwap thing, when you start providing liquidity to Uniswap and then you receive the SUSHI, is the cost basis just whatever the SUSHI is trading at, at that moment?

Shehan Chandrasekera:

So in the case of Uniswap, that’s a whole different conversation but usually the easy way to think about Uniswap is you’re providing liquidity. Then you close your position with your liquidity pool. If there’s a difference you’re going to pay taxes on the P&L, the profit and loss. So that’s just the Uniswap. How I think it should be taxed, although I know once you put the coins into a liquidity pool, then the ratio changes and it just doesn’t make sense for anybody to track those ratio changes and treat them as individual sale. It’s just too much work for no reason. Just speaking of yield farming, generally everybody’s doing it a different way. Platform is doing it a different way. Every time you earn something like a governance token or earn interest that’s treated as ordinary income and that establishes the cost basis for that token and then when you later sell it you’ve got to pay capital gain taxes on the difference between the cost basis and the sales price. 

Then you do this multiple times and you’ve just got to make sure that you track all of them. 

Laura Shin:

Okay. So the value for the SUSHI when they were doing that vampire mining on Uniswap would be just whatever it was trading for at whatever the trading price was for SUSHI. Is that the cost basis?

Shehan Chandrasekera:

That is correct. Again, it’s not direct tax guidance that has been issued by the IRS. This is how I think it should be treated in a more practical way because there’s nobody to answer these questions except us. So, yeah. 

Dan Hannum

Yeah. There’s still a lot of gray area in the inference between what’s written and using other guidance to kind of put together what we would recommend. The good thing from a pure accounting or tax perspective, as far as on the opposite side, how are they taxed but then how can you track this and how can you easily and accurately report this? The good thing is because a lot of these platforms, whether it’s a Uniswap, Sushi Swap, Maker Compound, down the list, most of the time you’re interacting with a wallet address, whether that’s a MetaMask or a MyEthereumWallet or one of these other providers. 

The good thing with our software and I believe CoinTracker as well is you can just enter in that wallet address. So, I know in our last question we had mentioned entering in manual entries or entering custom CSVs for the average user or even for myself trying to do that with DeFi or yield farming or something like that would get pretty complex but the good thing is you can enter in an address and then we’ll pull in that transaction data directly from that address, where it went, what pool you went into, what pool you came out of, things like that. So, after you kind of sort through how it’s taxed, on the opposite side, being able to report that accurately and concisely and getting that into your tax forms has become a little bit easier because you’re getting the distributions out to a wallet address and then you can just enter that wallet address and we can see the activity in that address. 

Laura Shin:

Obviously, with a lot of the yield farming, people were making crazy amounts of interest for allowing their tokens to be borrowed or whatever it was. So, how does earning interest get taxed by the IRS?

Shehan Chandrasekera:

I mean generally speaking, earning interest, at the time you receive it you just have to pay taxes based on the market value. That interest is taxed as ordinary income. Again, I know it sounds like interest but technically speaking it’s not considered interest because for you to earn interest income you’ve got to put money in a certain institution. So, in this case you’re not dealing in money. Instead of money we are putting property. So, I would say it’s more like other income but either way the tax treatment is the same. You’ve just got to pay order income taxes at the time you receive it equal to the market value at the time your receive it. 

Laura Shin:

Okay. So, it depends on what your income bracket is what amount you’re going to pay?

Shehan Chandrasekera:

That’s correct, yeah. 

Dan Hannum

Then you have a separate form for that as well, and I think that may be a segment we’ll get into as far as what are the tax forms, what are they used for. But with the Schedule 1, you’ll have a listing of that income that comes in, which is separate. Then an 8949 or a Schedule D or some of these other tax forms that are kind of more focused on a purchase or a sale of an asset versus just the interest or income that comes in. 

Laura Shin:

Okay. So, this is interesting because basically for people doing yield farming depending on the complexity of the transactions that they’re doing they could be paying capital gains taxes in addition to ordinary income taxes even if it looks kind of like a single cycle of yield farming. Is that right?

Shehan Chandrasekera:

I actually wrote a post about this. In my opinion, when you say yield farming it consists of at least seven to eight transactions, meaning you’re opening up a loan, you’re getting interest and then you’re selling the second token to another one. In all those different layers, so if transactions have different ways of getting taxed and your entire tax bill depends on the summation of those seven or eight transactions. So, it is really hard to say how should yield farming be taxed. It’s hard to say because every platform is doing it a different way. Then that yield farming phenomena consists of at least seven or eight transactions. 

Laura Shin:

All right. Well, super fun for you guys and I’m sure the IRS is going to love this when they really get into it. Okay. So, another new thing, well it’s not really new but with Ethereum 2.0 I think it became a bigger thing with staking or validating, how does that kind of activity get taxed?

Shehan Chandrasekera:

I’ll start with Ethereum 2.0 because that’s the big news because Ethereum is the second biggest currency with the market cap. So, again, we still don’t know how it’s going to look like in the real world because I hear some exchanges are providing some type of liquidity token while your original 20 or 32 Ethereum are being locked in the Ethereum smart contract. So again, I actually explained this on my Twitter as well. We can speculate how it’s going to look like but we just don’t know how exactly this will play out in the real world. But generally, speaking about staking, something like Tezos, the conservative way to create it is at the time you receive those staking rewards you had to pay other income taxes based on your income tax bracket. So that’s the most conservative way to go about that. 

Laura Shin:

All right. That is true because there are different ways to stake and I did do an episode with James Slazas of Dharma Capital because they launched Liquid Staking I think is the name of the company and I do think they’re giving people tokens because I think you can do a fraction rather than the full 32 ETH as your deposit. So interesting. All right. We briefly did talk about airdrops but why don’t we go through that in terms of what people need to know and report for their taxes. 

Dan Hannum

Yeah. I mean I think we covered some of it in the sense that a traditional airdrop would just be taxable ordinary income from the income that comes in from that airdrop. Most of the time, especially with an airdrop a lot of the times, especially maybe hardcore Bitcoin users that have been around for a few years, whether it’s BSV or BCH or some of these. There’s 100 different bitcoin forks, a lot of the times though, not want to keep the fork and they’ll actually trade that fork right back in for additional bitcoin. So, it kind of just depends on what you do with that airdrop, what you do with that fork. Then with the airdrop we went through kind of how you could track that, how you could report that. Shehan mentioned the UNI airdrop or the 1Inch air drop. Those are kind of pretty large airdrops this year where it kind of depended on how many addresses you use to interact with the protocol. So, with Uniswap you could actually have 100, 200, 300 different wallet addresses that all interacted and all received an airdrop. So, it becomes a little complex but using software like either of ours really allows you to kind of simplify that process. 

So, the income that you’d receive from the airdrop would just be included among other income, whether that’s mining, whether that’s staking, whether that’s “interest.” Then what you do with that asset moving forward if you keep that asset then you go into that holding period. If you trade that asset in, same thing, holding period, gains, losses, so there’s kind of a duality. Not necessarily there is a double tax but there is just multiple factors of once you receive that airdrop what you do with it. But the air drop itself would largely be considered taxable income. That comes in. Then we mentioned figuring out what the USD value was of that air drop when you received it. And then we’ve seen some, as Shehan mentioned, and I think anyone that kind of lives in this space. There’s a lot of gray area and a lot of lack of guidance around an airdrop and when do you actually own that airdrop. So, do you own that airdrop when it hits your wallet? Do you own that airdrop when you actually claim that token? Do you use that airdrop when you actually move that token? There’s a lot of gray area in the sense that we really just haven’t had a clear guidance directly from the IRS. 

So, firms like ours, our tax attorneys, Shehan, CoinTracker, other platforms in this space try to typically recommend more of a conservative approach. At the end of the day, you are putting your names on these tax forms. So, you have a little bit of optionality of what to do, but we typically recommend taking a conservative approach and then listing that income along with any other income that you’re getting from your crypto asset activity. 

Laura Shin:

One other factor with the airdrop and also the fork would be if you have those coins on that exchange when that exchange makes those coins available to you. Because as we all remember from when Bitcoin forked into Bitcoin Cash and bitcoin…there were several exchanges, Coinbase probably being the most famous one where people could not access their Bitcoin Cash until four months later or more than four months later. I guess that would then affect your cost basis, right, because if the price at the time of the fork is different from the price at the time that you receive it on the exchange then you would have a different cost basis. 

Shehan Chandrasekera:

Correct. So, I think the concept that we are talking about here is called dominion and control. So, IRS actually came out with the guidance in 2019. So, IRS pretty much said that you have a taxable event at the time you gain dominion and control of the coins that you get. So, it’s not the time you claim it because the claiming doesn’t mean that you have actually control over it. It’s the time that you see your coins on the wallet and you have the ability to do whatever you want with that. On that specific time, that’s when you have a taxable event and you’ve got to report the order income equal to the market value at the time you gained the dominion and control. 

Laura Shin:

Okay. And I just had a realization because this has happened to me. Let’s say that you have some coins in some kind of wallet and that wallet receives an airdrop or whatever it might be but then you cannot access that wallet anymore. So, you still owe taxes on that money. This totally happened to me, by the way. I lost a fair amount of Ether. But anyway, sad story. I was trying to buy my dot-ens name because I knew there were squatters after it and miserably failed. But anyway. 

Shehan Chandrasekera:

That’s a good question. Again, I would answer that question using logic. So yeah, I mean obviously, at the time that coins hit your wallet you have a taxable event, but if you could prove that you no longer have control over that wallet, you don’t have the private keys I don’t think you should recognize income. It just doesn’t make any sense because you don’t have the dominion. You have the dominion but you don’t have the control over that wallet because you just don’t have access to it. So I would not record it. But at the same time, I would not claim a loss because that might raise a red flag to the IRS. So, just disregard it and I know it’s sad but what can we do. 

Laura Shin:

Okay. So, I think we went through pretty much all the major transactions that people will be interested in. There might be some others that I didn’t think of but I think that’s pretty comprehensive. But then there are actually certain things that people might do with their crypto that they don’t need to report or that wouldn’t be taxed. So, what are some examples of those?

Dan Hannum

I mean honestly at this point, with the treatment of it as property there’s really not that many that don’t come under some sort of tax. I think the clear one is using dollars to purchase crypto. So, if you go into an exchange and you put in 100 bucks and buy Bitcoin, Ethereum, etcetera, that itself is not a taxable event but then tracking that cost basis and figuring out what you did with that token moving forward would be. So, I think that’s a clear one is the purchase of crypto with fiat or using dollars to purchase crypto is one that’s not necessarily a taxable event but would likely need to be tracked depending on what you do. As far as other ones, I mean there’s not really that many as far as any time you make a trade. As we walk through, there’s kind of a misconception of using crypto and purchasing another crypto that that should be considered a purchase. But as the treatment of property or essentially selling one piece of property and acquiring another piece of property. So, that crypto to crypto transaction typically covers 95 percent of all activity, whether it’s some type of yield farming, some type of just trading. Then we get into margin trading, futures, options, derivatives, and those all have taxable events. So unfortunately, for the US-based taxpayer there is not that many buckets or types of transactions that aren’t taxable in some regard, but I don’t know if Shehan had any that didn’t come to mind for me. 

Shehan Chandrasekera:

Yeah. I’ll give you two more examples in addition to what Dan mentioned because this is a question that I get all the time. Transfers between exchanges and wallets that you own are not taxable. It doesn’t matter, your portfolio is a million bucks or 10 million bucks. If you’re transferring from Coinbase which you own to another exchange or wallet that you own it’s not taxable. So, that’s a second one. The third one is if you are receiving a gift or if you are sending out a gift, those are not reportable transactions because if I am receiving it like a gift that’s not income. Of course, you would say yes to that crypto question on page 1040 but there’s no tax obligation. So, I would say those are the other two situations that you could have something to do with crypto but there’s no taxes. 

Laura Shin:

Then what about…oh, go ahead. 

Dan Hannum

I was going to say just to add on to that not necessary with another aspect but I think have we got, especially back in 2017 or 2018 was some users that were like why do I need to upload my wallet addresses? There’s no taxable events. All I’m doing is transferring back and forth. But seeing that transfer allows us to then properly attract that cost basis between exchanges, between the wallets, between protocols so that when you make that purchase we can see what lot or depending if you’re using LIFO, HIFO, FIFO or a specific ID where that came from. So, I just wanted to put that out there as well because I think we got a lot of questions. I imagine CoinTracker does as well of why do you need to see my wallets. There’s no taxable events that are occurring in the wallet specifically if you’re just transferring back and forth. But seeing those transfers allows us to have a complete flow of funds that we can look at and then be able to track cost basis according to your transaction flow. So, I just wanted to add that in because it’s definitely a frequent question that we see a lot. 

Laura Shin:

Yeah. And for people who don’t know that LIFO, FIFO whatever is just last in first out, first in first out, which are different ways to determine cost basis for your taxes. But as they were saying earlier in the episode, specific idea is even better because then you can really do the tax loss harvesting really well. Okay. One other thing is what about stable coin purchases or transactions? How are those taxed or do they even need to be reported or whatever?

Shehan Chandrasekera:

I mean the purchases using USD stable coins is not taxable. There are some stable coins, theoretically they are pegged to USD one to one but there’s some minor fluctuations. Sometimes .99, 1.01. I mean unfortunately, if you want to be really conservative, those are taxable events for those .1 or minus .1 or plus .1. But on an annual basis, if you’re constantly transacting with stable coins those fluctuations kind of even out. So that’s my take on that. 

Laura Shin:

Yeah. Maybe just in case you’d want to do it but it’s not going to have a huge material impact. 

Shehan Chandrasekera:

Exactly. 

Laura Shin:

All right. We’ve been talking about some of the kind of different forms and this issue with the wallets versus the exchanges but I’m curious, what are exchanges typically doing in terms of the types of forms they’re sending out. I actually looked myself and it doesn’t appear that there is kind of a general what’s the word I’m looking for, general standard for the way people are doing it because Cash App sends a 1099-B and Coinbase sends a 1099-MISC. So, what are all the different forms that people might receive and how would that affect what they would do with their taxes?

Dan Hannum

Yeah. I mean the simple answer is what are exchanges doing? Not enough. It’s been an issue for quite some time, and we haven’t seen much precedence, even an example is Coinbase was actually sued by the IRS for transaction data, for customer records and still has not really given much thought or effort to having a robust solution. So, from an exchange perspective or even a service provider perspective we haven’t really seen much attention or much care for the individual taxpayers. It’s make sure you come in, make sure you pay your trading fees and then good luck on the backend. So, we’re now starting to see more exchanges, especially this year, with the movement of the 1040 and increased IRS enforcement not only from enforcement but investment. That exchanges and service providers are really starting to care more about how do we serve our customers on the backend. As far as the forms, I think we both kind of smirked a little bit when we heard the 1099-B or 1099-K or 1099-MISC because we’ve seen multiple forms that really don’t provide a comprehensive report. I know Shehan had mentioned earlier if you’re using a TD Ameritrade or ETrade, typically an investor is using one platform and all the activity is happening on that platform. So, I come into Schwab and I put in 100 bucks and I make some trades and then at the end of the year I have my 1099 and then I’m pretty much done. 

With crypto, the average investor that we’ve seen with our dataset is using anywhere between 6 to 10 different exchanges. Then they’re using anywhere between 10 to 15 different wallets. So, that’s an average user. We have some users that are using hundreds of different exchanges, hundreds of different wallets, they’re making hundreds of thousands on millions of transactions every year. They have automated bots. So, you can get pretty crazy with it. But yeah, I mean I think not to shill either of our platforms too hard, but I think the value of our platform is we’ve kind of gone in to do a lot of the grunt work for our customers and our clients. Instead of having to put together a spreadsheet from Binance and Coinbase and Gemini and Kraken and all these other things. We allow you to aggregate all your exchange activity, all your wallet activity. We do all of the kind of messy hard work for you and then spit out these nice, clean tax forms that you can either file yourself, send to your tax professional. I believe we both have TurboTax integrations where you can one click and drag and drop right into TurboTax and be done. 

So, yeah, we’ve definitely seen exchanges and service providers not really care too much just yet. We’re starting to see that from a partnership perspective as well where exchanges are now looking for both of our platforms to help them handle their clients. You mentioned staking platform. Before we’ve seen Slingshot or Staked or some of these other platforms that are understanding that what they’re doing on the platform has a taxable event. Same thing with a like a Fold. These other providers are now starting to realize that if they can provide easy to use and accurate tax software for their clients it makes it a more enjoyable experience. So, not to get on too much of a tangent there, but I think we’re starting to see exchanges care. Our platforms and our software really do a lot of the dirty work for you of aggregating all of that, and I think that’s where the complexity of crypto comes from is that you’re trading on five or 10 different venues. You’re trading between 10 or 20 different blockchains that all have different ways to view them. You’re trading between different wallets and things like that. So, the more complexity you have the more you typically need to use a software like one of ours, but that’s just my opinion and my perspective. But on the 1099-K and the 1099-B it really doesn’t give the taxpayer, unless the taxpayer is just using Coinbase. If you sign in, all you do is put dollars in Coinbase, you make your trades just on Coinbase, you do nothing else. Then there’s some ability to say those tax forms are useful, but the vast majority of people in crypto are not using one exchange. They’re not using one wallet. They’re using multiple. When you start mixing wallets you can start mixing blockchains. The ability to track your cost basis accurately, reliably, and quickly becomes a little bit harder. Then that’s where our software kind of comes in to help that process for our clients. 

Laura Shin:

So, you were essentially saying these forms are old. They are from kind of the time before crypto and so none of them is really perfect for reporting crypto and so that’s why we’re not seeing the exchanges kind of pick one form to send. It sounds like you’re also saying that even for you, this provider in the space, you’re not really using the forms. Is that what I’m getting?

Dan Hannum

I mean pretty much. For us…

Shehan Chandrasekera:

So, let me tell you the fundamental problem that we are having in the crypto space, right. So, if you’re dealing with TD Ameritrade or JP Morgan, it’s easy for them to internally track the basis because of the nature of the space. If I’m moving stocks from TD Ameritrade to JP Morgan, they communicate with each other. So, when I get the 1099-B from JP Morgan they know my cost basis. But in the crypto space, if I transfer my coins from my Ledger to Coinbase, I cannot expect Coinbase to know my cost basis. This is the problem. This is the reason why we don’t have uniformity when it comes to information reporting, and it’s not the exchange’s fault. It’s just the space. That’s why we need tools like CoinTracker and Zen Ledger because we are those third party intermediaries that aggregate all those sources and give the taxpayer what they need, and we are the only people who can do that because we are in the middle. Exchanges cannot do that, taxpayers cannot do that, it’s too complicated. It has to be that intermediary, so that’s why these crypto tax software are super important. 

Laura Shin:

Right. Because you would have visibility not just to know what happens on the exchange but even what happens in their Ledger or their MetaMask. Okay. Got it. All right. I was going to ask you a question about if someone is just using MetaMask or a Ledger or whatever what they would need to do, but it sounds like really it’s just that they need to plug into some kind of crypto tax software. 

Shehan Chandrasekera:

Exactly. Yeah. 

Laura Shin:

All right. So, let’s talk about one other new trend. It’s not really involving money but it is a kind of crypto transaction, which is NFTs became a little bit of a thing this year. By NFTs we’re talking about non-fungible tokens, which are sales of digital art or collectables. So, I don’t really know how this is taxed but my questions are divided into taxes from the purchaser side, so why don’t we just start there. So, if I’m collecting some kind of digital art then what do I need to report or log or do I pay taxes on that?

Dan Hannum

NFTs is definitely a new trend in crypto that we’re seeing. I think one of the benefits and one of the disadvantages is the fact that they’re based on different ERC standards, most of them. So, for example, with a lot of traditional crypto they’re based on ERC-20, TRC-10, TRC-20, BEP2, and those are really common standards that things can be built off of. So, if you look at the crypto ecosystem, five thousand of the ten thousand tokens are some form of ERC-20. So, in NFTs you have ERC-721 and 1155, which are the two main token standards that it can be built off of. The good thing is what the NFT or non-fungible token stands for is that you’re not swapping these as, for example, dollars, which you can swap one dollar for one dollar and it’s the same thing. You’re buying a specific and rare and unique form of property. The ability to track that is somewhat easy because most of things are happening on chain. So, you can see most of these platforms are using DAI or ETH or some type of crypto to purchase that transaction. If you go on an OpenSea or SuperRare or Rarible NFT platforms you’re not really able to go in with a credit card and purchase NFT. You’re using ETH or DAI or some type of crypto. So, seeing what you paid for, it’s seeing when you paid for it, seeing that acquisition, that cost basis is pretty easy. On the flipside, we’re just not really seeing the velocity of those NFTs like we are with crypto. So, we’re not seeing an ERC-20 token or ETH or DAI being traded back and forth a million times. We’re typically seeing it in the concept of a lot of NFTs are based on art, for example. So, a user that’s purchasing a piece of art, they’re not really reselling that every day or trading that material. They may sell it later on. For example, we saw the CryptoPunk say, I don’t know the exact dates, but within the last couple weeks we saw one that went for 700 thousand dollars. So, we’re seeing large purchases of NFTs not only on the art side but digital, digital music, digital content, digital creative assets as well. So, we’re starting to see the mixture of culture and currency come together, which I’m personally really excited about. But as far as tracking it from a tax perspective it’s somewhat similar in the sense that you’re still going to have a cost basis when you purchase that asset. There’s not really much you can do with the asset yet, and I think that’s the interesting part of NFTs is how do we make these things viewable. Do you put it on Decentraland or Somnium Space? Can you put it into a digital art museum and have people pay a fee to view it like you would with the Louvre or Museum of Natural Art or something like that? But not to get too much on a tangent there, the tracking of the purchases is pretty standard. Then because the asset is typically a 721 or 1155, being able to track where that asset went is pretty easy. Then if you sell that back into ETH or DAI or USDC or whatever then you’d have a similar accounting method just like you would with traditional crypto where cost basis, how long did you hold it, what did you sell it for, and things like that. So, it does become similar because a lot of times you’re not able to purchase the dollars and then you’re not able to sell that back into dollars. So, even the CryptoPunk reference I just brought up, that wasn’t a sale into dollars. That was crypto was used to purchase that asset from someone who paid crypto to purchase it originally, if that makes sense. So, because it’s still kind of in that crypto ecosystem and not hitting these fiat rails, you’re not seeing some of the complexity that could come with the accounting. So, I know that’s a little bit of a tangent there but hopefully that gives a little bit of kind of clarity and context to NFTs. 

Laura Shin:

Okay. Then I’m assuming for the creator their income from that is just taxed as normal ordinary income?

Shehan Chandrasekera:

I was going to say if you’re in the business of creating art I mean it’s just like getting paid in USD, instead you’re getting paid in some type of coin. So, yeah. 

Laura Shin:

Okay. Then I don’t know if this is different or if it’s similar but what about the people that are creating their own social tokens? There’s Alex Masmej, who created ALEX and then Marguerite deCourcelle created COIN. Because they’re kind of creating their own sort of money or economy, so I’m not sure how they handle their taxes for that. 

Shehan Chandrasekera:

I mean typically creation of something is not a taxable event. I think the question arises when that person decides to sell it for some amount of huge money. In that case, most likely, the cost basis and the sales proceeds will be taxed as some type of capital gain. So, I haven’t seen a lot of people…it’s not that prevalent yet, but I’m pretty sure as we move forward we’re going to see so many of these great transactions. There’s always going to be a lag behind the innovation and the IRS coming and telling the specific guidance. So, in that case, we just had to come up with the reasonable guidance based on what we know. 

Laura Shin:

I mean I think it’s like their fans are earning the coin by doing different things and their economy and then later there’s maybe a price attached. Anyway, we’re over an hour but we still have a few important questions. During the DeFi craze this past summer gas fees on Ethereum were quite high and in general high transaction fees have been an issue for quite a while on several different blockchains. How do those fees that people pay affect their taxes?

Shehan Chandrasekera:

Yeah. I mean if you create the gas fees correctly you could get tax benefits. Say that you’re transferring Ethereum from one wallet to another, you could add the gas fees to the basis. So, when you later sell that coin you would have a lesser gain because you’re kind of getting the benefit of paying for that gas fee. If you are selling in a transaction, you could reduce the sales prices with the gas fee. So, that would be you are kind of reducing that. So again, as long as you’re kind of reporting those things correctly and capturing those correctly you can get some type of tax benefits. Again, that’s where the crypto tax software come into play because there’s no way that you can do these things manually. 

Laura Shin:

All right. Then at the end of the year there may have been some people who made crypto donations because most likely over the course of 2020 people did see their crypto holdings go up. So how should those donations be handled tax-wise?

Shehan Chandrasekera:

Yeah. The donations are a great tool for your to reduce your taxable income. It’s just one of those rare situations where the IRS kind of gives you two benefits in one transaction. So number one, when you donate long-term coins to a charity you get to bypass the capital gain taxes. So that’s huge. Number two, you get the deduction equivalent to the market value at the time you send the coin to the charity and that deductions reduces your crypto income and also non-crypto income like W2, basis income, etcetera. So yeah, it’s good, but I wouldn’t make the charitable donation based on the taxes. I mean you should be motivated by other things, but it’s a good way to reduce your taxable income, generally speaking. 

Laura Shin:

All right. So there’s also kind of two really popular platforms for purchasing crypto currency that actually don’t do something that some of these other exchanges that we were discussing allow, which is they don’t allow people to withdraw their crypto to their own wallets. So, that means all they can do if they would like to dispose of it or not dispose of it but I guess gain control of those coins is they would have to sell it within the app. So how would that affect their taxes. What I’m talking about is PayPal and Robinhood here if I didn’t mention them. 

Shehan Chandrasekera:

Yeah. This is a great, timely topic, especially with Robinhood. So yeah, I think the problem with Robinhood and PayPal is that right now you cannot transfer out your crypto coins from those platforms to somewhere else. So for any reason, if you want to kind of completely move out of the platform you’re left with one option. That one option is you’ve got to cash out your crypto, get the cash, and go to somewhere like Coinbase and buy your crypto. The problem here is that when you cash out you’ve got to pay taxes. So, that’s pretty unfortunate because people should have the ability to move to another platform without having to pay taxes but these platforms just work in a way that if you want to move out, you got to cash out. Again, that’s the downside. But don’t get me wrong, there’s so much good things that are offered by these platforms as well. I mean especially Robinhood. It brought a bunch of retail milennial investors to finance and exposed them to crypto. So, there’s good stuff but there’s bad stuff as well. 

Laura Shin:

Perfect. So, for years, the crypto industry has been advocating for certain changes to the way crypto is taxed, in particular they would like to see what’s called a De Minimis exemption for crypto transactions, which means that under a certain dollar amount crypto transactions would not be taxed. So that would enable you to buy a cup of coffee with bitcoin without triggering a taxable event. What do you think the prospects are now for something like that to go through? 

Shehan Chandrasekera:

So this bill was introduced I think 2019 or something like that and then there was COVID happened and there’s a change in administration, so I don’t even know where this bill is right now. But for those of you who don’t know, it pretty much said if you’re transacting under 600 bucks or less it’s not a taxable event. So, that’s the bill. I mean it’s good for the adoption but at the same time the way that Bitcoin has been soaring over the past few years, for me it works more like an investment tool or a capital asset. I don’t see people spending it to buy a cup of coffee or stuff like that because I don’t think it’s designed to work as a currency, in my opinion. 

Dan Hannum

Yeah. I was just about to say, I think the nice thing about the De Minimis was just the sense that, and I may be wrong, but I don’t think it was specifically just around bitcoin, so I’m 100 percent onboard with Shehan and I wouldn’t use my own bitcoin personally to purchase Starbuck or Dunkin Donuts or anything like that. But I think if you have another asset that is currently used more as a medium exchange, I mean I personally believe that as we continue to see a price increase and stabilize in bitcoin, we’ll eventually get to kind of different aspects of money that it’s used for. We’re kind of still on that store of value range right now, but yeah, I think the nice thing is that it’s not just for Bitcoin. So, if you have other assets that you’d prefer to use, a Tron or something like that where there might be a higher supply where you can easily purchase more at roughly the same cost, then it kind of makes sense. I don’t think there’s been much new news. I think under the new Biden administration it’s kind of a wait and see with what Biden, Yellen, and some of the new appointments, where they go, where they started and how that kind of all plays out. 

Laura Shin:

Yeah. There was one other potential change that FinCEN flagged, which is the agency released a notice saying it intended to amend regulations so that so-called FBAR or foreign bank and financial account requirements are applied to crypto held overseas. So, what does that mean for crypto holders?

Shehan Chandrasekera:

Yeah. So, right now if you’re holding crypto in a foreign exchange or location it’s not subject to FBAR reporting. FBAR is like a form that you file with the FinCEN whenever you have any type of assets exceeding $10,000 in any time during the period. So, just to be super clear here, it’s not applicable right now. But in January, the FinCEN released a very brief note. I think 2020-02 or something like that saying that they intend to change that. Again, that’s all they said. So, if they pass that law, if you are holding crypto in something like Binance.com and at any time during the year it exceeded 10,000 bucks you would have to disclose it. It does not mean that you’ve got to pay taxes or anything like that. You just have to disclose it under the Bank Secrecy Act. 

Laura Shin:

Okay. All right. So, why don’t we end on tips for 2021? Because I think we can all feel in our bones that 2021 is going to be a big year for crypto. So, what are your tips for people to establish habits that would help them to establish now so that a year from now they can breeze through their taxes?

Shehan Chandrasekera:

Okay. So just know that IRS pretty much publicly said that they are going from this educational mode to more enforcement type starting 2021. So, I would say just stop playing games and just report your gains for crypto and then just make sure you answer your question correctly. Just be aware of how crypto taxes work. Just know little things like selling your long-term crypto is always beneficial. Do tax loss harvesting. Make sure you donate crypto if you have gained a big amount of unrealized gains and then last but not least make sure you use some type of crypto tax software because that’s the only way you’re going to know your right amount of gains and losses and if you don’t use one of those things you’re going to be overpaying taxes or you’re going to be understating your income and you’re going to expose yourself to the IRS. So, those are my points. 

Laura Shin:

Dan, what about you?

Dan Hannum

I think he gave a great summary. I mean we’ve seen personally with our new 2021 customers that are coming in for likely 2021 tax season, they’re purchasing, on average, 3.8 years’ worth of tax forms. So, we’re seeing a ton of increased adoption from a compliance perspective where they’re coming back and either amending ’17, ’18, ’19, ’20. They may have never filed for those years and they’re now filing for the first time. So, we’re seeing a lot of increased adoption not only from the movement of the 1040 question but we’ve also seen the IRS civil and criminal divisions now with investments into crypto tax software and blockchain analytics services to now be able to go out and use those softwares for enforcement. So, we’re seeing not only the increased compliance on the front end but increased enforcement on the backend. 

I think Shehan mentioned that tax loss harvesting is a huge ability to really offset your gains and the cool thing is that it can be used for crypto and non-crypto as well. So, if you have W2 income, if you have stocks, bonds, those types of things, donations is a big one. Then as we mentioned earlier, just keeping track of what you’re using I think is the biggest one. Shehan mentioned using a crypto tax provider. I strongly believe in both of our companies, we’ve raised venture capital. We have built solid teams, solid product, been around for quite some time, so using a crypto tax software is definitely a great tool. Then just making sure you’re keeping track of what you’re using. As we started a conversation, you don’t have to track every transaction or anything like that. Gas fees can be included in those wallet addresses, as we mentioned. So, just really making sure you’re tracking what you’re using and then using a crypto tax software is really kind of the bow on the end I guess. 

Laura Shin:

All right. Great. Thank you for helping me give listeners a very comprehensive show. Where can people learn more about each of you and Zen Ledger and CoinTracker and crypto taxes in general?

Shehan Chandrasekera:

I mean I’m pretty active on Twitter. My handle is @thecryptoCPA, so it’s pretty easy to find. If you need a crypto tax software tool you can go to Cointracker.io or you can go to Coinbase tax center, we are directly integrated there as well. 

Dan Hannum

As Shehan mentioned, my handle is not as nice. My handle is just DHannum8. Pretty active on Twitter. Our website is just ZenLedger.io and I think one thing that may be interesting to some of your listeners as well that may have outside crypto activity is in addition to our do-it-yourself options, we also have fully prepared tax professional plans. So, we have a team of tax professionals standing by that can help you with your crypto and non-crypto activity. So, if you just want someone to do it for you, sign off on it. I think that’s a big thing we’re seeing a lot of users that they want to make sure if the IRS comes knocking they’re knocking on the tax professional door and not their door. So, just another thing that may be interesting for some of your viewers that may have activity outside of crypto that just are looking for someone who can handle both. 

Laura Shin:

Great. Thank you, both, so much for coming on Unchained. 

Dan Hannum

Thanks for having us. 

Laura Shin:

Thanks so much for joining us today. To learn more about Dan and ZenLedger and Shehan and CoinTracker as well as crypto taxes check out the show notes for this episode. Don’t forget, you can now watch video recordings of the shows on the Unchained YouTube channel. Go to YouTube.com/c/unchainedpodcast and subscribe today. 

Unchained is produced by me, Laura Shin, with help from Anthony Yoon, Daniel Nuss, Shashank, and the team at CLK Transcription. Thanks for listening.