Invested in Cryptocurrency? What You Need to Know for the Tax Season
The fact is:
The IRS sees cryptocurrency mining and transactions as taxable events. The IRS documents their stance in Notice 2014-21, IRS Virtual Currency Guidance.
Here’s what you need to know about cryptocurrency and your taxes.
As with all tax situations, each person’s individual circumstances may vary. You should consult a tax professional to see how any specific situation impacts your personal tax return.
Mining cryptocurrency is how cryptocurrency comes into existence.
If you’re currently mining cryptocurrency, you’ll have to report each bitcoin or other units of another cryptocurrency you successfully mine.
The value of the bitcoin you mine at the time you mine it is what you’ll report to the IRS as income.
If you mine cryptocurrency as a trade or business, you’ll have to pay self-employment tax on the net earnings, also known as earnings after expenses.
The tax rules for trading cryptocurrency are considered the same as the rules for property such as stocks or mutual funds.
This guideline makes it easier to understand how Bitcoin transactions are taxed.
Whenever you buy property, you must keep track of the basis of the property.
This is what you paid to obtain the property or in this case the bitcoin.
You’ll also need to keep track of the date you bought the Bitcoin.
You don’t pay taxes when you buy the Bitcoin. Instead, you may have to pay taxes when you sell the cryptocurrency. The type of tax you’ll pay is considered capital gains.
How to Report Cryptocurrency Sales
When you file your tax return, you’ll report your cryptocurrency sales on Form 8489, Sales or Other Dispositions of Capital Assets. This form requires you to report each sale individually.
For each transaction, you’ll need to list the following as either a short-term (1 year or less) or long-term (greater than a year) gain or loss:
- the description of the property sold
- the date acquired
- date sold
- proceeds from the sale
- the cost basis of the sale
- the gain or loss from the sale
Most of the information is fairly easy to determine.
However, the cost basis is open to some slight interpretation.
You can either use your average cost of all of the particular cryptocurrency you own or you can use the actual cost of the specific cryptocurrency units you are selling.
Average cost is simple.
You keep track of the total number of particular cryptocurrency you own and its value. The basis is the total value divided by the number of cryptocurrency units you own.
This may require less record keeping, but may not provide the best benefit when it comes to optimizing your taxes.
The actual cost method is a bit trickier because you need details about every transaction. You can decide to sell specific cryptocurrency units using one of many methods.
First in, first out
One method you can choose is the first in, first out method.
This means the first cryptocurrency units will be the first pieces of cryptocurrency you sell.
This is easier because you can quickly look to determine which units to use the cost basis of.
Another option, called specific identification, is more complicated.
This allows you to look through every cryptocurrency unit you own and choose which ones you sell.
This requires keeping meticulous records, but can offer the biggest flexibility for tax benefits.
Once you complete Form 8949, the information will flow to Form 1040 Schedule D, Capital Gains and Losses.
Figuring Out Which Tax Rate You Pay
Capital gains taxes have two types of rates:
- long-term capital gains rates
- short-term capital gains rates
If you own the cryptocurrency for a year or less, it’s considered a short-term capital gain and you’ll have to pay ordinary income tax rates on the gain.
If you own the cryptocurrency for more than a year, it’s considered a long-term capital gain and you’ll pay the more favorable capital gains tax rates on the gain.
Offsetting Capital Gains with Capital Losses
Cryptocurrencies have taken some wild swings in value.
You don’t have to report these big swings until you eventually sell your cryptocurrency stake.
But what happens if you don’t have a gain to report?
Can you deduct cryptocurrency losses?
First, any capital losses you have will offset any capital gains reported on the same tax return of the same type.
That means long-term losses will offset long-term gains and the same with short-term gains and losses.
If you still have a net loss, you can deduct the remaining loss against the other type of gain.
For instance, if you have a short-term capital loss, you can use it to offset a long-term capital gain.
Finally, if you still have an overall net loss, you can deduct up to $3,000 of your capital losses against other types of income.
If your loss exceeds $3,000, you can use the remaining loss on future tax returns to offset capital gains.
If you don’t have any gains, you can use up to $3,000 per year against other income until your loss is exhausted.
Making Purchases with Cryptocurrency
Making everyday purchases with cryptocurrency is a nightmare for your taxes.
Each time you make a purchase with Bitcoin, you’ll have to report that transaction on your tax return.
Since the IRS doesn’t view bitcoin as a currency, but instead as property, you’re essentially selling the Bitcoin and using the proceeds to buy the property.
This is a taxable transaction just like trading bitcoin.
Each time you use a bitcoin to buy a sandwich or any other purchase, you’ll have to keep track of all of the necessary information related to the transaction which is a major pain.
You May Receive a Form 1099 for Cryptocurrency Activities
Depending on your trading activities and where you trade your cryptocurrencies, you may or may not receive a Form 1099.
Coinbase, a popular exchange, is currently issuing Form 1099-K for transactions that took place on Coinbase Pro, Prime and Coinbase Merchant.
If you complete at least 200 separate transactions that result in receiving at least $20,000 in cash for sales of cryptocurrencies within a calendar year, you’ll get a 1099-K. Other exchanges may or may not issue these forms.
What you probably won’t receive is a Form 1099-B, which details gains and losses on transactions. Instead, you’ll need to view records held by your cryptocurrency exchange or keep track of this information yourself.
Instead, you’ll need to view records held by your cryptocurrency exchange or keep track of this information yourself.
A Form 1099-K is sent both to you and the IRS, which makes the IRS aware of the income. Then, the IRS expects to match that income to your tax return. If they don’t see it, you could receive a notice for the IRS as it will result in a red flag.
Just because you don’t receive a 1099 doesn’t mean you don’t have to pay taxes on bitcoin or other cryptocurrency trading.
You should always report all income as required by the IRS.
Trying to hide income from the IRS isn’t something you want to do.
If you don’t report it, you could be in for a nasty surprise if you get audited or the IRS finds out about the unreported income in another way.
Tips to Make Your Taxes Easier
While bitcoin is considered a cryptocurrency, the IRS doesn’t see it as a currency. This makes using it as a currency a major burden for your taxes.
To make filing your taxes easier, you should avoid using Bitcoin for everyday purchases unless you have a system in place to record the relevant information needed for your tax return.
Without a system, you’ll be in a frenzy at tax time trying to figure out what every transaction was for and how to report it properly.
If you do trade bitcoin or use bitcoin for purchases, here’s what you should keep track of.
Keep track of transactions
If you’ve decided you want to invest or use cryptocurrency, it is extremely important to keep detailed records. In particular, you’ll need to track:
- Every time you buy bitcoin
- Date purchased
- Value per bitcoin
- Any transaction fees to purchase the bitcoin
- Every time you sell bitcoin
- Date sold
- Value received per bitcoin
- Any transaction fees to sell the bitcoin
- Every time you use bitcoin to make a purchase
- Date of purchase
- What was purchased
- Value of item purchased
- Current trading price of bitcoin
- Any fees to make the purchase
- Every time you exchange cryptocurrencies
- Date of exchange
- Value of each cryptocurrency at date of exchange
- Any transaction fees to buy or sell either cryptocurrency
Consider hiring a tax pro
Cryptocurrency can be extremely complex when it comes to your taxes.
The rules may change and it’s difficult to keep up with all of the moving parts.
For these reasons, it often makes sense to have a certified public account (CPA) or another professional tax preparer advise you about how your specific transactions will impact your taxes.
If this is the first year you’re dealing with cryptocurrency, it may make sense to pay them to prepare your tax return. Then, you can see how they specifically treat different types of transactions.
In future years, you can file your return yourself if you’re comfortable with how everything works.
However, most people will probably be better off letting a professional handle their cryptocurrency tax issues.