Tax Implications and Traps in Crypto that Can Occur When Trading Between Tax Years (2017 – 2018 as an Example)

If you bought crypto in early 2017, then traded in late 2017. Then you likely owe taxes on profits from 2017. This can pose issues given the current prices of cryptocurrency in 2018.

First, why would one owe taxes? You would owe taxes due to the fact that crypto-to-crypto trades are taxable events and because profits/losses are calculated within a calendar year.

Thus, if you bought in early 2017 when coins were cheap, and then traded in late 2017 when coins were very highly valued, and still have crypto here in 2018 where coins have lost a great deal of value, you likely are showing more profit on paper for 2017 than you likely have in your account in 2018 (and there is no way to write 2018’s loss off against 2017’s gains).

Logically, this sort of situation can apply in any set of years where one year had people seeing record gains, but the next had them seeing record losses. However, here we are in 2018, so let’s focus on using that as an example.

Let’s illustrate some potential issues that can occur, let’s go over an example case from 2017 – 2018:

You bought Bitcoin at $1k in early 2017, you then realized a profit of $18k per Bitcoin when you traded your 1 $19k Bitcoin for 47.5 Litecoin at $400 on December 18th, 2017 .

Now, here in early February 2018, almost every single coin has gone down by about 60% or so, and Litecoin is no exception.

Litecoin was $400, now it is $150 (we’ll assume you didn’t panic sell at $100).

So, you took your $18k profit from Bitcoin, you bought $19k worth of sweet Litecoins at the top, and now your Litecoins is worth $7,125 (don’t feel too bad, your Bitcoin wouldn’t have fared much better… of course, had you held you wouldn’t be dealing with taxes; anyways, here we are).

Now, let’s assume nothing happens between now and April 15th. Litecoin stays at that price and you make no trades.

That means on or before April 15 you’ll need to send out a payment to the IRS based on $18k worth of profit in 2017, but will have only $7,125 worth of crypto on hand.

Now, depending on your tax bracket, this is going to have different implications.

If you are lower income, you could lose assistance over this, but you won’t owe much taxes.

If you are higher income, you could owe like 20% – 30%+ on the profit.

So you would owe, let’s say 20% of $18k. Ok, well that is like $3.6k.

So $7,125 – $3,600 You now have less than $3,525 left over.

You somehow just turned $18k profit into $3.525k profit after taxes.

There is zero percent chance that feels good. You didn’t lose your principal $1k, and that is good, but you got set back pretty hard and now have only $3.525k to work with in 2018.

Now Imagine you are all-in on crypto and did this. Here is the “funny” thing, you have to cash out crypto before April 15th to pay your taxes. That means you are going to have to realize profits/losses before April 15th for the 2018 calendar year.

Now imagine you add a few zeros onto those numbers. If that is the case your tax rate is higher (more like 30%+) and the amount you have to take out by April 15th is higher.

So what is your gamble? Are you going to wait to see if prices go up before April? But… what if they go down?!

Welcome to the rabbit hole.

And this is just one example of a trap that crypto traders can fall into in any set of years (but specifically are subject to falling into in a set of years like 2017 – 2018 and 2013 – 2014).

Feels bad.

However, it can get way worse than this.

For example coins can go to zero on a bad day and cash traders who do margin trading are working with extra risks.

Here is an example of a worse case with margin trading:

Imagine you margin traded like a ninja in 2017, but then you went long when crypto turned bearish in early 2018 and liquidated your self down to zero (by making a series of bad leveraged trades). You might assume you can wave a white flag and call “do over” or something in a nightmare scenario like this…. but this is not the case at all. Instead you owe the IRS for all your 2017 profits. The IRS does not care that you lost everything gambling on Bitcoin in early 2018. That isn’t how taxes work.

What I’m saying is this:

Because crypto is volatile, because trading it is a taxable event, and because the calendar year and tax year are the same, there are these brutal traps one can fall into in cryptocurrency trading.

These traps are the most brutal in a set of years where crypto is up really big at the end of one year, and then down really big at the start of another.

Unfortunately for many of us, 2017 – 2018 is shaping up to be such as set.

Since this is the case, one smart thing to do is to figure out your tax situation now (it would have been smarter before January 1st, 2018; but better now than on April 15th).

Did you trade out of Bitcoin at $19k in 2017 and then buy a coin that suffered heavy losses like TRX, XRP, or LTC? If you did you are up in 2017 and down in 2018, and that means you are currently in a trap.

There are countless ways to deal with this, especially if you have the extra money (you deal with it by making the best moves you can now and sucking it up and paying the IRS).

Likewise, you can deal with this in your reporting by using an accepted reporting method that is beneficial to your situation (see a tax proffesional for advice).

Some will be able to dig themselves out, but others will be in a more sticky situation.

The more trapped you are, the more you have to make a plan for how you are going to get enough money to pay taxes by April 15th. Will you file an extension? Will you set up payments with the IRS? Will you cash out just enough crypto now and hold it until April 15th to be safe? Will you push it closer to the due date thinking crypto will go up? These are questions you have to answer.

Further, if you are dealing with a ton of crypto, you should realize that all the above can be true, while at the same time you could be realizing taxable gains this year anyways and thus could end up needing to make additional payments for your quarterly taxes (or you could need to amend for past years).

The point being, there are some trap-like rabbit holes to fall into with crypto trading, and not being aware of them is not a valid excuse.

If you aren’t in this situation, keep in mind you could be in any set of years in the future.

If you keep these traps in mind now, it can help you to avoid making choices that potentially lead to more traps.

When people buy and “just hold,” they aren’t always being foolish. Buying at $19k and then not selling means you don’t owe any taxes yet, buying at $500, trading at $19k, and then riding another coin into the ground from one year to the next… that is a more complex situation.

People don’t always realize all the risks they are taking with crypto. Trading can be good, buying and holding can be good, but letting your gains ride from one year to the next poses this complicated extra risk involving taxes.

The problem here isn’t crypto, as if we believe in crypto we simply have to wait for the next wave. The problem is the IRS wants to get paid now, not at some future date when your favorite coin goes to the moon. This plus all the other things we have noted here can result in some serious traps.

TIP: If you traded in 2017, found yourself in this situation, and aren’t sure of what to do, you may be able to make the case for like-kind property exchange (which would make it so crypto-to-crypto trades aren’t counted as taxable events). To do this, you must see a tax professional. In general, if you got yourself in a trap from trading in late 2017 and holding into 2018, you should see a tax professional no matter what. Traps this intense won’t happen often (not unless we get another year like 2017), but they can and did happen. So keep this in mind for the future.

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