Cryptocurrency Taxes for US Residents

Cryptocurrency and Bitcoin Tax Resources

Just a few years ago, Bitcoin and the myriad of alternative coins that followed were only known to tech-savvy professionals. Now, cryptocurrency is hot. So hot, in fact, that many financial professionals and government regulators are just now catching up. With more and more people using Bitcoin and other cryptocurrencies every day, there is a concerning lack of information available for those of us who want to get up-to-date on the hottest new technology in today’s financial markets.

What Is Cryptocurrency, Anyway?

If you’re not sure, you’re not alone. At the most general level, cryptocurrencies are alternatives to traditional currency. Bitcoins and some if the alternative coins – or “altcoins” – that followed it can be used to pay for anything from a cup of coffee to large equipment for your business. Anyone can buy, use, or sell cryptocurrency with the help of exchanges and digital wallets.

Whether you’re trading in Bitcoin, Ether, or any other altcoin, cryptocurrency transactions have tax impacts. This is especially true if you’ve been holding them in the hope their value will increase.

Why Invest in Bitcoin or Other Cryptocurrencies?

Currency is a store of value and a means of exchange, but it can also be used as an investment. This is true with traditional currencies – which have been traded for hundreds of years – as well as new virtual currencies.

Currency trading involves the purchase and sale of currencies – foreign, domestic, or alternative – with the expectation of profiting from favorable exchange rates. Just like governments and big financial institutions, have done with traditional currencies for generations, small investors are now buying virtual currencies and holding them with the expectation that they will profit from a positive exchange rate. However, because all currency fluctuates in value independently relative to every other currency, things can get complicated quickly. As a result, smart investors do their research before buying or selling cryptocurrency assets.

Do You Have to Report Cryptocurrency Transactions to the IRS?

Yes. Contrary to popular belief, you must report cryptocurrency sales and exchanges on your tax return. It doesn’t matter if you’re on a private blockchain or using a coin that has enhanced privacy features like Dash or Monero. If you’ve bought or sold cryptocurrencies in the past tax year, you must include these transactions in your return.

What Sort of Records Do the IRS Require for Cryptocurrency Transactions?

Selling your coins or tokens for traditional money or buying something with your coins are taxable events. You don’t have to report when you make your initial actual purchase, but you should keep good records of how much you paid and how much it sold for. You then report the sale in the appropriate year’s tax return.

If you sell your virtual currency, then you should keep a record of your basis (what you paid), the date of purchase, date of sale, and your proceeds or losses. Everything in the digital world happens quickly, so sometimes it’s hard to keep records on every transaction. However, record keeping is extremely important for cryptocurrency investors. Unlike most brokered securities, blockchain-based currencies don’t keep information that is automatically recorded and reported to the IRS. So, good recordkeeping is the responsibility of you and your accountant.

What Happens if I don’t Report my Cryptocurrency Transactions to the IRS?

Short answer: nothing good. Coinbase, the only cryptocurrency exchange licensed by U.S. regulatory agencies, recently battled the IRS over tax liability involving over 14,000 user accounts. The IRS is investigating Coinbase users for failing to report crypto-exchanges in the past few years. Depending on the circumstances, this may result in onerous penalties and interest for those that didn’t report their transactions and profits.

The IRS is using the same aggressive strategy with Coinbase investors it used to thwart tax evasion among Swiss banks. While Coinbase was the low-hanging fruit with respect to a federal enforcement case, other exchanges and cryptocurrency owners definitely will be next. So, a word to the wise: report those sales!

How Does the IRS Tax Cryptocurrencies?

The IRS characterizes cryptocurrency based on what you intend to do with it. If you received cryptocurrency payments in a trade or business – like being paid for your services or for sales of intellectual or tangible property – they are taxed as income based on what the cryptocurrency was worth on the sale date. Mining income is also taxable and reportable as self-employment income.

However, if you’re trading cryptocurrency like stocks or other securities, then the capital gains and losses rules apply. In these cases, the IRS treats Bitcoin and other virtual currencies as property, so cryptocurrency transactions follow the general principles of property taxation. So, for example, if you held it longer than a year, it’s a long-term gain that has more preferential treatment than short-term gains. Since the bottom two tax brackets pay 0% capital gains tax for lower income earners, this has made cryptocurrency an attractive option when it hits peaks and early adopters didn’t pay much for the first few issuances of Bitcoin and Ethereum. Short term capital gains are taxed at a higher ordinary income tax rate so any transactions of coin that weren’t held for a year will cost you more in taxes.

When Do You Have to Pay Taxes on Cryptocurrency?

If your cryptocurrency investment drastically appreciates in value after purchase, your taxes won’t be affected until you sell. This applies regardless of whether you cash out for traditional currencies like U.S. Dollars or Euros or whether you trade one digital coin for another.

Some traders are under the impression that cryptocurrency trades only become taxable if you convert your coins to traditional currencies, like U.S. Dollars or Euros. This is not the case. Rather, all digital money in your wallet or on an exchange after a sale is subject to potential tax liability.

What if I Invested in Cryptocurrency This Year But Didn’t Make Any Money?

If you sold at a loss during some of the volatility often experienced in the market, or any other time for that matter, you can deduct up to $3,000 per year in capital losses until that loss has been used up. Harvesting losses is an effective way to cut your tax bill if you’re concerned about being pushed into a higher bracket as far as your other assets are concerned. It’s definitely can be a good idea to sell off any cryptocurrency that lost value and if you’re hesitant to keep holding it, and you have capital gains to offset it against as a year end tax planning maneuver.

What Every Cryptocurrency Investor Needs to Know About Taxes: Hire a Professional.

Whether the IRS will eventually change the classification of cryptocurrency is yet to be determined. With all of the changes going on in the federal tax code, it remains to be seen exactly how cryptocurrencies will be taxed in the future. But no matter what classification it gets, you’ll definitely need to report your cryptocurrency transactions and keep good records of how much your coin was worth the day you bought in then what it was when you sold it.

Fortunately, help is available. Happy Tax has developed CryptoTaxPrep.com to help Bitcoin and altcoin traders with their accounting. The service includes tax planning to minimize any tax liability without running afoul of the law. Post any crypto tax questions in the comments or send an email to mario@theproblemsolver.com.

About the Author

Mario Costanz is a lifelong entrepreneur and has had built and sold a number of successful businesses in the internet, restaurant, real estate and income tax preparation industry. He was named to the “One to Watch” section of Accounting Today’s 2017 Top 100 Most Influential in Accounting List. More information and contact can be found at https://CryptoTaxPrep.com, https://GetHappyTax.com, https://facebook.com/mariocostanz or https://linkedin.com/in/mariocostanz.

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