Bitcoin may be an unregulated asset, but the taxman still wants a cut of your transactions.
Bitcoin and other virtual currencies are taxable, which means all your bitcoin transactions must be reported on your tax return.
“As far as the IRS is concerned, it doesn’t matter – for US taxpayers – where the bitcoin is bought or sold. You have to report it on your tax return and declare any income or capital gain or loss,” explains Steve Skancke, Chief Economic Advisor at Keel Point.
That said, bitcoin tax reporting can be as confusing as the crypto-currency itself. Here are a few points to help you understand how bitcoin is taxed:
Bitcoin is a property, not a currency.
How you receive bitcoin is important for tax purposes.
IRS reporting.
Bitcoin is property, not currency
The first thing to know about bitcoin is that it is property in the eyes of the IRS. Despite how you might view or use it, the IRS says that for tax purposes, bitcoin and other digital currencies are not currencies; they’re capital assets, which means they’re taxed like stocks.
“Since the IRS considers bitcoin a capital asset, it makes no difference whether you sell it as an investment or transfer it to another party as payment for goods or services,” Skancke explains. “Any variation between its value at the time of sale or transfer and its acquisition cost is treated as a capital gain or loss and taxed accordingly.”
This is actually good news for long-term bitcoin owners, as it means you’ll benefit from more favorable tax treatment. “Bitcoin is taxed at the ordinary income rate, which is less favorable than the capital gains tax rate,” explains Eric Pritz, senior partner at Signature Estate & Investment Advisors.
If you hold bitcoin for more than a year before selling it at a profit, you’ll only have to pay 15% capital gains tax (20% for those earning $441,450 or more and down to 0% for those earning less than $80,000). On the other hand, if you hold it for a year or less before selling it, you’ll pay ordinary income tax on any gain, depending on your tax rate.
How you receive bitcoins is important for tax purposes
The way you receive and use bitcoins can affect the taxes you pay. For example, mining bitcoins creates a taxable event. You should calculate the fair market value of the bitcoin on the day it was mined and pay income taxes on that value, says Tyson Romanick, financial analyst and portfolio manager at Baker Boyer.
You can determine fair market value by converting the crypto-currency into U.S. dollars (or another real currency, which can then be converted into U.S. dollars) based on the established exchange rate listed on the exchange. The fair market value corresponds to the value of the crypto-currency at the date and time the transaction is recorded on the distributed ledger. If the transaction is not recorded on the distributed ledger, then you can use the time at which it would have been recorded if it had been a recordable event.
So, if you were to use your bitcoins to buy a car, you would have to determine the fair market value of the bitcoins on the day you bought the car. “You can think of it as if you had sold your bitcoin, but instead of getting money in exchange, you received another valuable item,” explains Romanick. The difference between the cost basis of your bitcoin, which is usually the amount you paid to buy it, and its fair market value on the day you bought it, will result in a gain or loss that you declare on your tax return.
There are few bitcoin transactions that don’t give rise to an immediate taxable event, for example if you receive bitcoins as a gift or donate them to charity. However, once you have the donated bitcoin, you will have to pay taxes accordingly, which means you need to know the basic cost of the donated bitcoin. This depends on whether you make a gain or a loss at the time of sale or donation: if you make a gain, your basis is the donor’s basis, plus the donation tax paid by the donor. If you have a loss, your basis is the lesser of the donor’s basis or the fair market value at the time you received the gift. And if you have no way of knowing the donor’s basis, you must record a cost basis of zero dollars.
IRS reporting
As you can see, it’s essential to keep meticulous records of your bitcoin transactions when tax time rolls around. Unfortunately, because owning digital currency isn’t as straightforward as owning stocks, the institution where you hold your currency may not issue a Form 1099 to help you with your tax return, Pritz explains. “It’s up to you to notify the IRS of gains and losses associated with taxable events related to bitcoin.”
The IRS recommends keeping records documenting any receipt, sale, exchange or other disposition of digital currency and the fair market value at the time of the transactions.
The potential upside is that if you have to record bitcoin capital gains, you can also deduct capital losses, explains Ben Weiss, COO of CoinFlip, one of the largest cryptocurrency ATM providers in the U.S.
The Financial Crimes Enforcement Network also recently announced plans to change the requirements for reporting foreign bank and financial accounts to include crypto-currencies in foreign accounts as a reportable account.
“As a general rule, individuals must report any financial interest outside the country that exceeds $10,000,” explains Weiss. With this change, cryptocurrencies like bitcoin will count as reportable financial interests.
