Buying and selling cryptocurrency can be exciting, especially when you start to turn large profits. However, each of these bitcoin transactions, including buying, selling, and mining, are taxable as property for all US taxpayers. To those who aren’t tax experts, this may not sound like a difference. The distinction informs what information American residents will need to collect in their records and their techniques to minimize their tax liability. With more contractors and employees accepting bitcoin for payment in whole or in part, these considerations are more important than ever before.
The content in this post is not financial advice. Rather, bitcoin investors can use it for information purposes to buy and sell crypto. For personalized tax advice, taxpayers should engage with a tax professional.
Since 2014, the IRS views convertible virtual currencies like bitcoin and any action to buy or sell crypto as taxable. For taxation purposes, the government views cryptocurrencies as property rather than a currency. Therefore, tax rules that apply to property like collectible coins and vintage cars will also apply to bitcoin. The government agency has boiled this down to a “realization event.” To put these events into layman’s terms, here is a quick overview.
- If you are mining bitcoin, the value of the bitcoin earned is taxable
- If you use bitcoin by cashing it on an exchange or buying a product or service and the price of bitcoin is higher than when you bought it, you are required to pay taxes
- If your bitcoin investment was held for less than a year, the IRS would tax it as a short-term gain; if it is more than a year, the IRS will tax it as a long-term gain
- If you use bitcoin by cashing it on an exchange like Bitcoin Up or buying a product or service and the price of bitcoin is higher than when you bought it, you are required to pay taxes
Users might wonder if the IRS will ever notice. The answer is yes. The failure to report income, including on the sale of crypto, will result in a notice from the IRS. If taxpayers continue to ignore the warnings, the IRS will begin charging an interest rate of 0.5% of the tax owed, which over time can accumulate to 25% of the unpaid balance. Failure to pay these fees may even result in liens against your property or a levy against your bank account. Those who are unsure of their reporting obligations are encouraged to consult with a tax-planning professional to avoid these costly penalties.
Managing taxable transactions
Users need to be diligent in tracking their cryptocurrency activities. Anytime a user miners, buys or receives the currency, they must record the price. When it comes time to use or sell it, users can calculate their taxable liability.
Typically, if an investor buys or sells stocks, their broker will give them a copy of Form 1099-B to show the amount of income earned. Since most bitcoin exchanges don’t provide this level of detailed information, bitcoin investors need to track this themselves.
When it comes time to report these currencies, individuals should record their transactions on the first page of their tax return. Taxpayers will need to check the appropriate box next to the question, even if they received the bitcoin without paying for it.
Calculating capital gains and losses
To calculate capital gains on bitcoin, consider this example. Let’s say you purchase Bitcoin for $25,000, and it increases to $45,000 in six months when you decide to sell it. The government would calculate your short-term gain as $20,000 based on your tax bracket, set by the rest of your income. Say you were to hold your bitcoin for more than a year. In this case, you would be taxed at 0%, 15%, or 20%, depending on your total income.
Although the IRS does not take pity on the majority of income earned with bitcoin, they do allow investors to deduct capital losses if they sell the digital currency at a loss. Considering capital losses, investors can offset their gains or large taxable income to reduce the amount of taxes they pay.
It may seem unlikely, but those holding currencies may have their bitcoin stolen. Unfortunately, the new tax rules have recently done away with the deduction for personal theft losses.