The rise of cryptocurrencies and their growing acceptance by the business and financial community has created interesting investment opportunities in the crypto space. Among these, day trading is the most popular, as it’s easy to get into and can provide substantial profits.
Day trading also comes with tax-related responsibilities that are different from those related to long-term profits. Investors need to understand how to handle these taxes so that they can avoid penalties and keep as much of their income as they are allowed to.
The Basics of Crypto Taxes
Cryptocurrencies are relatively novel assets, and governments have decided how to treat them by comparing them with traditional assets. The US government and most other governments in the world don’t treat crypto as money but as property, at least when it comes to how they are taxed.
Tax rates also depend on how long a trader holds on to an asset. Governments favor holding assets for long and accruing profits based on interest. This isn’t the case with day traders, as they buy and sell assets quickly to profit from the margins.
Taxes are charged on transactions, which is another issue day traders need to prepare for, as they make a lot of transactions by design.
Frequent Trading
The law treats assets held for more than a year differently than those held for shorter time periods. Since day traders buy and sell crypto within hours and sometimes even minutes, their gains are treated as short-term capital gains and taxed as such.
Short-term capital gains taxes are treated as income, meaning that the more a person makes, the more they are taxed. The rates range from zero to 37 percent, depending on the income bracket. It’s also important to note that if day traders have other income, such as salaries, it also goes towards this amount and can bring the overall income into a higher bracket.
Record Keeping
An essential part of handling crypto taxes is to keep a careful record of all transactions and, therefore, justify your spending and profits to the tax authority. These records need to include the date of the transaction and the amounts in crypto and fiat currency on the day and time the transaction was made.
Since all of these transactions happen online and via apps that keep track of those transfers, it’s on the trader to carefully collect and categorize these in order to avoid mistakes and penalties. It’s a common practice to have a backup system for these as well.
Calculating Your Taxes as a Day Trader
The best crypto tax software does most of the work, but it’s still important for a trader to understand how taxes are calculated. In order to do so, traders should understand the concept of cost basis. It refers to the original value of cryptocurrency when the trader has purchased it. Simply put: if a trader buys crypto for $10,000 and sells it for $12,000, they pay taxes on the $2,000 they’ve made.
There are three common methods to calculate the cost basis. These are:
- First In, First Out –This means the first coins the trader has bought are also the first ones to sell. It’s the method preferred by the tax authorities.
- Last in, First Out – The most recent coins are sold first.
- Specific Identification – With this method, the investor chooses which coins to sell and when.
When choosing which software tool to use, look for one that supports a variety of accounting methods.
Reporting and Hiring Help
Once the investor has collected the proper documents and calculated their taxes, they need to report it to the authorities. Some tax software tools do that as well. In most cases, the report is done as with the exchange of other capital assets.
US taxpayers also need to answer the questions about the currency itself in a separate form, while other countries don’t have such a process set up yet. Given the complexity of the system and the number of transactions day traders have, it may be useful to hire a tax consultant before reporting.
How to Minimize Crypto Taxes
Taxes paid on profits from day trading can’t be avoided. However, there are ways to reduce and even minimize the tax burden by knowing and following the rules. The most common strategy for doing so is known as tax-loss harvesting. This means selling crypto assets at a loss to offset the taxable gains.
There are also deductions that the traders should take advantage of. These cover fees and expenses related to trading, which are deductible from the overall tax bill. Another way to reduce taxes is to hold assets longer, but this may not always be applicable to the concept of day trading.
To Sum Up
Day trading is a common way to earn money in the crypto market, and it can be very lucrative. There are also tax obligations that the investors need to be aware of and cover. Crypto assets are taxed as property and not currency, and the taxes are higher if the assets are held for less than a year, which is the case for day traders.
The tax rate rises as the investor earns more, and their other income counts towards calculating the tax bracket they are in. It’s essential to keep careful track of all the data, and there are software tools to help with that.
Comments by Alyssa