By Why Cryptocurrency Exchanges Can’t Provide Accurate Tax Information to Users
Cryptocurrency exchanges like Coinbase have seen incredible growth over the recent years. As of this writing, Coinbase boasts more than 25 million users on its platform. As impressive as this stat is, it comes as a bit of a shock that when it comes to taxes, most cryptocurrency exchanges are unable to provide accurate documentation to their users. This article breaks down why the tax implications of crypto pose such a problem for exchanges and also offers a solution.
Cryptocurrency Exchanges
Cryptocurrency exchanges like Coinbase, Bittrex, and Poloniex make it easy for everyday consumers to buy and sell cryptocurrencies. By nature of the technology that these exchanges operate on (blockchain), users are able to send Bitcoin and other cryptocurrencies to wallet addresses outside of their own network. An example of this would look like you buying Bitcoin through Coinbase and then sending it to a Binance wallet address to acquire new coins and assets on Binance that Coinbase does not offer.
Being able to send cryptocurrencies to other locations and other wallet addresses is core to the whole premise of crypto. However, this core principle is also the culprit behind the massive Coinbase tax problem.
A quick rundown of how the IRS treats cryptocurrency for tax purposes in the US
Depending on what country you live in, your cryptocurrency will be subject to different tax rules. The below addresses implications within the United States, but similar issues arise around the world.
In the US, the IRS treats cryptocurrencies as property for tax purposes. Just like other forms of property—stocks, bonds, real estate—you incur a tax liability when you sell cryptocurrency for more than you acquired it for.
In this sense, cryptocurrency trading looks similar to trading stocks for tax purposes.
For example, if you purchased 0.1 Bitcoin for $1000 in March of 2018 and then sold it two months later for $2,000, you have a $1,000 capital gain. You report this gain on your tax return, and depending on what tax bracket you fall under, you will pay a certain percentage of tax on the gain. Rates fluctuate based on your tax bracket as well as depending on if it was a short term vs. a long term gain.
On the flip side, if you sold your cryptocurrency for less than you acquired it for, you can write off that capital loss to save money on your taxes. It’s also important to report your cryptocurrency mining taxes.
So why can’t Coinbase or other exchanges provide me with my required tax reports?
To fully understand this problem, you need to understand how capital gains and losses are calculated. To calculate your gains/ losses, you simply apply this formula:
Fair Market Value – Cost Basis = Capital Gain / Loss
What is Cost Basis?
Cost Basis is the original value of an asset for tax purposes. In the world of crypto, your cost basis is essentially how much it cost you to acquire the coin. Sticking with our example above, if you paid $1,000 to acquire 0.1 Bitcoin on Coinbase, your cost basis is $1000 for that Bitcoin.
What is Fair Market Value?
Fair market value is just how much an asset would sell for on the open market. Again with cryptocurrency, this fair market value is how much the coin was worth in terms of US dollars at the time of the sale. So if I sold that same Bitcoin on Coinbase for $2,000, that would be my fair market value.
Using the formula, you can see that in this case, you have a $1,000 capital gain.
$2,000 – $1,000 = $1,000 gain
The Tax Problem
So here’s the huge problem: Because you can send cryptocurrencies into Coinbase, Coinbase has no possible way of knowing how, when, where, or at what cost you acquired that cryptocurrency that you sent in. Coinbase only sees that it showed up in your coinbase wallet.
This means that anytime you move crypto assets like bitcoin off of Coinbase or into Coinbase from another location, Coinbase completely loses the ability to provide you with accurate tax information. This is because it has no way of identifying what your cost basis is in that certain cryptocurrency which is an ESSENTIAL piece to figure out your capital gains or loss for bitcoin taxes.
As you can see pictured below, Coinbase explains to their users themselves that their generated tax reports won’t be accurate if you have done any of the following: Bought or sold digital assets on another exchange, sent or received digital assets from a non-Coinbase wallet, sent or received digital assets from another exchange including Coinbase Pro, stored digital assets on an external storage device, or participated in an ICO.
That’s a lot of exclusions, and it likely accounts for over half Coinbase users are left high and dry when it comes to accurately reporting taxes.
The Bigger Problem
As previously mentioned, this doesn’t affect just Coinbase. Every cryptocurrency exchange out there that allows users to send and receive cryptocurrencies from other platforms (essentially all of them) face this exact same problem.
This means that millions of cryptocurrency users cannot rely on their exchanges to provide them with accurate tax reports. It is simply impossible for the exchange to do so.
Maybe you’ve seen all of the frantic posts on the internet of cryptocurrency exchange users freaking out because of the tax reports they tried to generate from Coinbase and how they are completely inaccurate.
The Solution
The solution hinges on aggregating together all of your cryptocurrency data that makes up your buys, sells, trades, air drops, forks, mined coins, exchanges, swaps, and received cryptocurrencies to build out an accurate tax profile that contains all the necessary data.
Crypto tax software exists for cryptocurrency traders to provide a solution to this problem. Using this type of software, traders can aggregate their historical data by pulling in their transactions from all of the exchanges and platforms that they use. All of these transactions get sorted and matched to the historical USD price at the time of the transaction. This allows for automatic tax report creation.
In Summary
Cryptocurrency exchanges are not able to provide their users with accurate tax information due to the nature of the technology they operate on. If you are one of the many facing this problem, it can be wise to leverage tax aggregating tools to stay compliant.
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