Most people buy and sell cryptocurrencies on exchanges like Coinbase. But if you’re an enthusiast or HODL’r, you may prefer to keep at least some of your digital assets in a software or hardware wallet like a Ledger.
While wallets offer more privacy and security, they can create headaches when tax season rolls around. Many crypto exchanges provide Form 1099-B—and soon Form 1099-DA—but if you trade in and out of wallets, you’re on your own!
The good news is that you no longer have to crack open a spreadsheet; crypto tax software can help aggregate transactions across wallets and exchanges. This article demonstrates how to set yourself up for success.
What Are Crypto Wallets?
Crypto wallets are a bit of a misnomer—they don’t “hold” your crypto. Your crypto assets technically live on the blockchain. Instead, crypto wallets hold your private keys that prove ownership of these assets on the blockchain.
There are several types of wallets:
- Paper Wallets: Paper wallets are simply pieces of paper containing your private keys that you can store in a safe place, such as a wall safe. Since the key is entirely offline, you don’t have to worry about digital theft (only the physical variety).
- Hardware Wallets: Hardware wallets are thumb drives containing your private keys. Since they’re offline by default, you don’t have to worry about security most of the time. But you can plug them in to quickly access your digital assets.
- Online Wallets: Online wallets are like online vaults—you can sign in with a password or MFA and access your private keys. You still have custody of your private keys, but it’s a little riskier than hardware or paper wallets.
Most crypto wallets record transactions you’ve made with your private key. Typically, you can download these transactions into a CSV file. Alternatively, you can always see them on the blockchain itself.
How Crypto Taxes Work
The IRS is doubling down on its crypto tax enforcement, so if you’re not already up-to-speed, it’s worth taking the time to understand how crypto taxes work.
There are two types of crypto taxes:
- Ordinary Income: You owe ordinary income tax on any crypto you receive as compensation (e.g., wages) or earn as part of a business (e.g., mining). Generally, this is taxed at your marginal income tax rate.
- Capital Gains: You owe capital gains tax on any price appreciation between buying and selling a crypto asset. If you have held it for over a year, the IRS charges a lower tax rate than if you have had it for less than one year.
The complicated part comes into play when determining your capital gain. You must know how much you originally purchased a crypto asset to calculate your gain. And that’s challenging if you use many wallets and exchanges.
For example, suppose you purchased Bitcoin on Coinbase, sent it to a hardware wallet, and then transferred it to a friend. The hardware wallet has no way of knowing how much you paid for it on Coinbase, and Coinbase has no idea you sold it. However, the IRS wants to know your profit on the asset, not on a specific wallet or exchange.
To compute your capital gain, you must download your Coinbase transaction history and your hardware wallet transaction history and reconcile them. Until recently, this process involved large spreadsheets, with each row being a transaction.
Why Use Crypto Tax Software
Crypto tax software can help streamline the process by sorting transactions from different exchanges and wallets into a unified database. In ZenLedger, we can even provide you with a spreadsheet version we call the Grand Unified Accounting report!
ZenLedger makes it easy to import transactions. Source: ZenLedger
Most crypto tax software solutions enable you to connect to popular crypto exchanges via API to sync transactions. Then, if you have a hardware wallet, you may need to upload a CSV version of the transactions with standardized column names to match.
Once you’ve imported transactions, you can usually generate the tax forms you must file each year. While most solutions offer the basics, like Form 8969 and Schedule D, we offer advanced forms and the ability to file everything on our platform.
ZenLedger also provides a tax-loss harvesting tool and a fully transparent spreadsheet to help you prepare an audit defense if necessary.
How to Import Transactions
Importing transactions may vary depending on your crypto tax software, but ZenLedger makes the process as easy as possible.
ZenLedger makes it easy to gather transactions from blockchains. Source: ZenLedger
Most wallets can import transactions in three easy steps:
- Navigate to the Import page and search for the wallet in the search box.
- Select the blockchain your wallet address is on and add your public wallet address.
- Click on Import to import the transactions from the blockchain.
If your wallet or coin isn’t supported (or if you use paper wallets!), you can still import the transactions by creating a Custom CSV or using Manual Import. We also provide a Custom CSV Template that you can use to streamline the process.
Other Tax Gotchas
Importing transactions can become more complex if you’re involved in more unconventional crypto transactions.
For example, consider the case of a crypto bridge. If you put Ethereum into a bridge and receive another token, should you treat the Ethereum as “sold”? The conservative approach is “yes,” meaning matching up transactions on both sides of the bridge.
We support many of these transactions in ZenLedger, from minting non-fungible tokens (NFTs) to receiving decentralized finance (DeFi) rewards. But, if you use another platform, you should understand the tax treatment of these transactions.
Finally, you should deduct the transaction fees or gas you pay in any crypto transactions from your total profit (or add them to your loss). These are deductible expenses that can help lower your overall tax obligation.
The Bottom Line
Crypto wallets are a popular way to secure private keys from prying eyes—but they can also complicate your tax situation. Fortunately, crypto tax software like ZenLedger can help you streamline the tax prep process and address most concerns!
However, keep in mind that importing transactions is only one part of the broader tax prep process. It’s critical to take steps throughout the year to ensure compliance, such as making estimated payments or filing extensions on time.
If you have a complex crypto tax situation, contacting a CPA or other tax professional for help may also make sense. They can often help you develop more comprehensive tax plans for your non-crypto assets and situations.
Get started with ZenLedger for free today!
This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.
