In a NutshellBitcoin is making headlines. Even if you’re not sitting on a serious investment, you may be curious to know how bitcoin is taxed. And if you invested or have been paid in cryptocurrency, it’s important to understand the tax ramifications.
It was definitely a good year for cryptocurrencies in 2017, with bitcoin surging over 1,200 percent last year.
If you invested in bitcoin or other cryptocurrencies in 2017, or received some as payment, you may be wondering how bitcoin is taxed. Here’s how cryptocurrency could affect your taxes.
- How does the IRS treat bitcoin and other cryptocurrencies?
- What constitutes a taxable event when using your bitcoin?
- How can I calculate my bitcoin earnings or losses, and how are they taxed?
- Where do I report gains or losses for cryptocurrency trades, and what forms do I use?
- What if I bought some bitcoin and I’m just holding it?
- I got paid in bitcoin last year. How does that affect my taxes?
For federal tax purposes, the IRS regards cryptocurrency as property. So the tax principles that apply to property transactions also apply to convertible cryptocurrencies. Whether you realized a gain or a loss from the property transaction will influence how the transaction affects your taxes.
Like stock or tangible assets, cryptocurrency can be considered to have a taxable gain or loss. If the fair market value of the cryptocurrency you received exceeds your adjusted basis for the property, you’ll have a taxable gain.
If the fair market value is less than your adjusted basis, you’ll have a loss. Both can affect your taxes, but in different ways. And just as you would report stock market gains as income, you must count the fair market value of cryptocurrency in your gross income.
While bitcoin might be the talk of the town, hundreds of other virtual currencies exist. Whether they’re other big ones — like ethereum, ripple or litecoin — or a lesser-known name, the IRS guidelines apply to all convertible cryptocurrency.
Nonconvertible cryptocurrencies do exist. They are intended for use only in a specific domain or virtual world and can’t be exchanged for real currency. So while the IRS will want to tax your bitcoin gains, it’s probably not interested in your “World of Warcraft” gold.
In a nutshell, cryptocurrencies are subject to the same tax principles applied to property transactions. The IRS identifies a taxable event as any time you buy, sell or trade a cryptocurrency to pay for goods or services.
Confusion may arise when buying and selling virtual currencies as an investment, like selling some bitcoin in exchange for ethereum.
Some people might think that it’s a like-kind property swap covered by Section 1031 of the tax code, but the IRS has not yet addressed whether this type of exchange qualifies as a Section 1031 exchange.
If you receive virtual currencies as payment or income for products or services you provide, that would also be a taxable event. Mining cryptocurrency is a taxable event, as well.
So it’s important to accurately track all your cryptocurrency trades and record the value of each one at the current fair market value in U.S. dollars as of the date of receipt.
If you’re investing in bitcoin (or other cryptocurrency), your gains or losses and their impact on your tax liability depends on multiple factors.
First and foremost, how long you held onto your bitcoin can affect your tax liability. If you held cryptocurrency for longer than a year before disposing of it, you’re likely looking at long-term capital gains or losses.
If you held your bitcoin or other cryptocurrency for one year or less before disposing of it, you could be looking at short-term capital gain or losses.
So if you were day-trading bitcoin, you’ll be looking at tax rates on short-term capital gains. The tax rate varies depending on your income tax bracket. However, according to the IRS, the tax rate on most net capital gains is no higher than 15 percent for most taxpayers.
If you have capital losses to report or you traded a cryptocurrency for less than your adjusted basis, then you must report those losses as well. These losses can offset your gains, giving you a slight tax break.
If you had some bad timing with virtual currencies and your capital losses exceeded your capital gains, then you can use that loss to offset up to $3,000 of other income.
When holding virtual currencies as a capital asset, much like you would other investments like stocks or bonds, you report them on your taxes as a capital gain or loss. You will often need to file a Form 8949 to report a sale, exchange or other disposition of your virtual currency, along with your Form 1040 and Schedule D, to summarize and report your capital gains and deductible capital losses.
This is where it’s important to keep records of the fair market value in U.S. dollars of all your transactions at the time of receipt. This information will be noted on your Form 8949 and Schedule D, and used to calculate your net capital gain or loss.
One thing to note is that some cryptocurrency exchanges may not issue you a Form 1099-K, which summarizes your investments. This is why it’s very important to keep good records.
For example, one of the largest U.S. exchanges, Coinbase, issued a statement that only select customers trading more than $20,000 would receive a 1099-K. Coinbase does, however, provide an exportable list of your trades, using first-in, first-out methodology for calculating your net capital gains or losses, which you can use to fill out your Form 8949.
Remember: Just because you don’t receive this form doesn’t mean you don’t have any taxable income to report!
What happens if I fail to report cryptocurrency gains or losses?
Failing to report capital gains or losses on cryptocurrency would be the same as if you failed to pay taxes on your investments. The IRS could come after you, and you could face legal issues and financial penalties for avoiding taxes. This is also true for any transactions prior to March 25, 2014, that are inconsistent with the current IRS guidelines.
If you have transactions before March 25, 2014, you can always file amended returns for those years on Form 1040X and account for your virtual currency income in a way that aligns with current IRS guidelines.
The IRS may also offer you relief from any penalties if you are able to establish that any underpayment or failure to file the right returns is due to reasonable cause.
It’s best to avoid the headache of filing amended returns by accounting for your cryptocurrency gains or losses on your return. Accurate and organized record keeping is key.
Many people may fall into this situation: You heard about bitcoin at the kitchen table or over the holidays, so you bought some. What if you’ve just held onto it all year?
Simply buying bitcoin with your own money does not create a tax liability. If you have not gone a step further and traded or sold your bitcoin or used it to purchase something, you may not need to report since there hasn’t been a disposition of property and, theoretically, you’ve already paid taxes on the money used to buy the cryptocurrency.
For now, your best bet is to continue keeping records of your investment moving forward.
If you received bitcoin or another cryptocurrency from an employer, that income should be reported just as you would your salary on a W-2 subject to federal withholding.
If you received bitcoin or another cryptocurrency as payment for services you performed for someone else as an independent contractor, you must report that as self-employment income and it may be subject to self-employment tax.
Any payments made to you with cryptocurrency at a fair market value of $600 or more should generate a 1099-MISC for tax purposes and are taxable as miscellaneous income.
If the value of your cryptocurrency changes between the time you received it and when you file your tax return, you would report the fair market value of the virtual currency on the date you received it.
You can calculate the fair market value based on an exchange that trades the virtual currency and has a market value based off supply and demand.
If you’re mining bitcoin, then you report the gross income of the bitcoin you successfully mined at the time of receipt. However, if you are mining bitcoin as a business for yourself (not as an employee for someone else), then that income is self-employment income and is subject to self-employment tax.
What is bitcoin?
The technical definition for cryptocurrency is a digital currency that uses cryptography for security, distribution and verification. Sometimes cryptocurrency is also referred to as digital or virtual currency.
From a user’s perspective, the cryptocurrency marketplace is essentially multiple software programs that allow users to have a personal virtual wallet where they can send and receive cryptocurrency.
These transactions occur through a fully online ledger, known as the blockchain. This means there’s no need for a central bank or other authority to facilitate transfers.
To buy cryptocurrency, like bitcoin, you’ll probably need to use real money for the initial purchase. For example, if you’re buying through an app like Coinbase, you create an account and attach a payment method, such as a credit card, to the account.
You could also attempt to take up bitcoin mining, which can be a way to “uncover” bitcoins by lending your computer’s resources to do work for the blockchain.
The growth of bitcoin
The concept of cryptocurrency has been around since the late 1990s, but a cryptographer using the alias Satoshi Nakamoto is generally credited with developing the specifications and proof of concept for bitcoin in 2009.
Since then, bitcoin has grown immensely to become the face of cryptocurrency. As of January 29, 2018, its total market cap is more than $186 billion. The total cryptocurrency market cap as of Dec. 31, 2017, was over $224 billion. Bitcoin alone saw over $12 billion of 24-hour transaction volume that day.
Bitcoin and a growing number of competing cryptocurrencies such as ethereum, ripple and litecoin are becoming more commonly used in real-world applications.
Many businesses have adopted cryptocurrency, but especially bitcoin, as a form of payment. Overstock.com, for example, accepts bitcoin as payment.
However, the majority of cryptocurrency users hold their assets as investments. So while you could go out and buy something with bitcoin or send some to friends to pay them back for dinner, you’re probably looking to hold onto it as an investment.
However you ended up with cryptocurrency, it’s important to make sure you’re prepared come tax time. IRS Notice 2014-21 explains how bitcoin is taxed and makes assessing your tax situation when it comes to bitcoin and other virtual currencies a little clearer.