Do I have to Pay Taxes on Cryptocurrency? | Cryptocurrency Tax Preparation by Genesis Tax Consultants, LLC ©
Cryptocurrency Tax Basics You Should Know©
While the cryptocurrency market is down across the board currently, if you are looking to get out
or get in the speculative game of trading fiat currency, gains or losses will come nontheless and with tax consequences . So everyone dumping or pumping their dollars and euros into fiat money like Bitcoin, Ethereum, and Litecoin, many are still confused about how the tax treatment of it for federal income tax purposes. In 2014, the Internal Revenue Service (IRS) made it clear that virtual currency will be taxed as a capital asset, provided they are convertible into cash; meaning that capital gains rules apply to any gains or losses. Sounds simple enough right? Here is why it may not be as easy as that:
or get in the speculative game of trading fiat currency, gains or losses will come nontheless and with tax consequences . So everyone dumping or pumping their dollars and euros into fiat money like Bitcoin, Ethereum, and Litecoin, many are still confused about how the tax treatment of it for federal income tax purposes. In 2014, the Internal Revenue Service (IRS) made it clear that virtual currency will be taxed as a capital asset, provided they are convertible into cash; meaning that capital gains rules apply to any gains or losses. Sounds simple enough right? Here is why it may not be as easy as that:- Buying and selling cryptocurrency for speculative investment purposes will have gains and losses, basis, holding period and a triggering event calculated the same as when purchasing and selling stocks.
- Using cryptocurrency to pay for goods or services, or to buy other cryptocurrencies is a triggering event for tax purposes, meaning the result will usually end up in a loss (but the possibility remains for a gain or wash).
More complicated cryptocurrency tax issues:
HOW DO YOU CALCULATE CAPITAL GAINS ON CRYPTOCURRENCY?
For tax and accounting purposes, capital gains and losses are calculated by determining how much your cost basis has gone up or down from the time you acquired the cryptocurrency until a taxable event is triggered.
How to calculate the basis in cryptocurrency:
Basis is the cost that you paid for the cryptocurrency. The actual cost is sometimes referred to as "cost basis" because you can make adjustments to basis over time. For example, if you add to the asset, either as a new purchase or a reinvestment, your basis is your cost plus the cost of each subsequent purchase/reinvestment.
When I trade cryptocurrency on an exchange, I pay commissions and fees. How do I treat those costs?
When you calculate the basis of your cryptocurrency, you will figure the purchase price plus any related costs, such as commissions. Fees are treated differently. If you pay investment-related fees, then you may be able to deduct the fees on your Schedule A, assuming you itemize. But that's only for 2017. The new tax reform law eliminated the deduction for 2018 through 2025 but there is a work-around: If, instead of owning cryptocurrency personally, your business owns the investments, you can deduct investment-related fees on a Schedule C (or your entity's tax form).
What is considered a taxable event when dealing with cryptocurrency?
A taxable event occurs after a sale or disposition of an asset. When it comes to cryptocurrency, a taxable event occurs whenever it is traded for cash or other cryptocurrency or whenever cryptocurrency is used to purchase goods or services.
There's also another potentially complicating factor. The IRS doesn't require third-party reporting for virtual currency (yet) so there's no form 1099-B or equivalent issued at the end of the tax year. Some companies like Coinbase will offer a summary of transactions which can be used to help you file your taxes but if you withdraw cryptocurrency from an exchange, the exchange can no longer track when happens. In that way, it's the same as taking money out of your bank. For that reason, cashing cryptocurrency out of an exchange or similar platform may be treated as a sale - even if the withdraw is forced.
What is a holding period?
The holding period is the time you acquired the cryptocurrency until the time of the taxable event (i.e. you sold it, exchanged it for other cryptocurrency, or used it to purchase goods or services).
- Holding your cryptocurrency for more than one year before a taxable event is considered a long-term gain or loss.
- Holding your cryptocurrency for one year or less before a taxable event is considered a short-term gain or loss.
For example: Kevin bought 100 shares of stock on Jan. 1, 2018. To determine his holding period, he should begin counting on Jan. 2, 2018. The second day of each month thereafter counts as the beginning of a new month, regardless of how many days each month contains. If he sells the property on Jan. 1, 2019, his holding period will be one year or less and he will realize a short-term capital gain or loss. If he sells the property on Jan. 2, 2019, his holding period will have been one year and a day, and he will realize a long-term capital gain or loss.
Capital Gains Rate vs. Ordinary Income Rates
The capital gains rates can be favorable to taxpayers. For 2017 (the return that you'll file when tax season opens in January 2018), capital gains rates for long term gains (those held more than a year) range from 0% to 20%. Short-term capital gains are taxed as ordinary income, which means your marginal tax rate will apply to your short-term gains as well (in 2017 ordinary tax rates are 15%, 25%, 28%, 33%, 35%, and 39.6%). After 2018 the tax rates go to 10%,12%,22%,24%,32%,35%, and 37%. So if you make more than $37,950 in 2017 you will be in the 25% tax bracket, so you would end up paying at least 5% more than you would on a short-term gain than you would on a long-term capital gain.
What happens when you lose money on cryptocurrency?
If your realized losses exceed your realized gains, you have a capital loss for tax purposes. You can claim up to $3,000 (or $1,500 if you are married filing separately) of capital losses and the amount of your loss offsets your taxable income for the tax year. If your losses exceed those limits, you can carry the loss forward to later years subject to certain limitations and restrictions.
What are realized gains and losses?
Cryptocurrency has been up and down over the past year. For tax purposes, you mostly care about the beginning and the end: what happens in the middle doesn't really count. For example, every time that Bitcoin takes a dive, that doesn't equal a real, or realized loss. Similarly, when it goes back up, that doesn't equal a real, or realized gain. To realize a gain or a loss for tax purposes, you have to do something with the asset. Typically, that means that you sell it or otherwise dispose of it - generally, the taxable event mentioned earlier.
Here's a quick example to help you sort out the math: Assume you invest in Bitcoin worth $1,000. Over the year, assume that the value of the Bitcoin climbs to $25,000 due to market conditions and not any additional investment on your part. You continue to hold onto it. Result? Unrealized gain, no capital gain. Now assume that the value of Bitcoin takes a hit and it falls to $500. Result? Unrealized loss, no capital loss. Finally, assume that Bitcoin climbs back to $750 and you get rid of it. Result? You have a realized capital loss of $250 ($750 selling price – $1,000 basis). You take the loss at the basis, not the high price (the $25,000 high value is meaningless for purposes of capital gain or loss) nor at the low price (the $500 low value is similarly meaningless for purposes of capital gain or loss). You want it to mean something. But it doesn’t. At least not for tax purposes.
So where do I report my gains or losses?
At tax time, you’ll report your realized gains and losses on a Form 8949 and summarized on Schedule D attached to your Form 1040, Individual Income Tax Return, where you will transfer the results to the reconciliation page. You will not file a 8949 Schedule D if you do not have any realized gains or losses: even if the value changes, if there's no sale, exchange, or use for products and services there is no taxable event to report.
So what if I invest in cryptocurrency outside of the United States. I know that I have to report brokerage accounts and other assets on an FBAR. Does that apply here?
As of the date of this post, you do not have to report your cryptocurrency on your FBAR. In 2014, the IRS issued a statement, saying, "The Financial Crimes Enforcement Network, which issues regulatory guidance pertaining to Reports of Foreign Bank and Financial Accounts (FBARs), is not requiring that digital (or virtual) currency accounts be reported on an FBAR at this time but may consider requiring such accounts to be reported in the future." The IRS has confirmed that position for 2017 taxes.
The IRS has been cracking down on cryptocurrency reporting. They've made some headway into investigating potentially unreported transactions, including some initial success in legal efforts to force Coinbase to turn over customer records. It's likely not an isolated push: In the Coinbase matter, IRS Senior Revenue Agent David Utzke noted that for the 2013 through 2015 tax years, the IRS processed, on average, just under 150 million individual returns annually. Of those, approximately 84% were filed electronically. IRS matched data collected from forms 8949, Sales and Other Dispositions of Capital Assets, which were filed electronically and found that just 807 individuals reported a transaction on Form 8949 using a property description likely related to bitcoin in 2013; in 2014, that number was just 893; and in 2015, the number fell to 802. The IRS argues that those numbers indicate that taxpayers aren't reporting or paying tax on cryptocurrency transactions.
It is no secret that the Internal Revenue Service is making reporting cryptocurrency a compliance priority. Stay ahead of the game by making sure your records and tax reporting are above-board, if not end up paying hefty penalties and interest on unreported income (not to mention the potential of jail time, yikes!).
-If you need someone to prepare your current or back years tax returns look no further. Contact me today. Nicholas Hartney, EA