Once a curiosity among the tech-savvy, cryptocurrency has evolved into a hot-button issue for financial professionals, regulators, and people seeking alternatives to traditional currency. Bitcoins and crypto are now used to pay for anything from a cup of coffee to institutional purchases like lab equipment with the help of exchanges and digital wallets.
Whether you’re trading in Bitcoin, Ethereum, or any altcoin of your choice, cryptocurrency transactions have tax impacts. This is especially true if you’ve been holding them in the hope their value will increase.
When Do You Have to Report Crypto Transactions?
Contrary to popular belief, you do need to 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 your cryptocurrency of choice drastically appreciates in value after purchase, your taxes won’t be affected until you sell if, even if you trade one coin for another denomination. Buying something with your coins or tokens is also a taxable event. 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.
This type of record keeping is extremely important since unlike most brokered securities, this information isn’t automatically recorded and reported to the IRS (referred to as a covered transaction, while basis that isn’t recorded by the broker then recorded is called a non-covered transaction.) Coinbase recently lost their battle against the IRS to have over 14,000 user accounts investigated for failure to report crypto-exchanges in the past which may result in onerous penalties and interest for those that didn’t report their crypto transactions and profits. The IRS is using the same strategy they used to stop tax evasion with Swiss banks, and the other exchanges and cryptocurrency owners will definitely be next. So, make sure to report those sales!
The IRS characterizes cryptocurrency based on your intent with it. If you received cryptocurrency payments in a trade or business (being paid for your services or receiving it for sales of creative work like music), you’d have to recognize it as income and convert the cryptocurrency amount to cash based on what is worth on the sale date. However, if you’re trading cryptocurrency similarly to stocks or other securities, then the capital gains and losses characterization and rules would apply. Mining income is also taxable and reportable as self employment income.
If you profit from the sale of your virtual currency, then you’d have to take note of your basis (what you paid), the date of purchase, date of sale, and your proceeds. If you held it longer than a year, it’s a long-term gain which has more preferential treatment than short-term (held less than a year.) 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.
Some traders are under the impression that crypto trades only become taxable if you withdraw your coins to your bank account in fiat (USD). This is not the case, even money that stays in an exchange after a sale or is swapped for another coin via a service like ShapeShift are taxable events and need to be reported.
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.
Whether the IRS will eventually change the classification of cryptocurrency is yet to be determined. 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 of choice was worth the day you bought in then what it was when you sold it.