An As Simple As it Gets Breakdown of Cryptocurrency and Taxes
To summarize the tax rules for cryptocurrency in the United States, cryptocurrency is an investment property and you owe taxes when you sell, trade, or use it. With that said, “the character of a gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer.”
That is the gist of cryptocurrency and taxes in the U.S., below we explain some details and clarify the implications of the above.
NOTE: We aren’t tax professionals and can’t offer tax advice. This is simply a compilation and summary of our research on cryptocurrency and taxes. Make sure to see the official guidance below and contact a tax professional if you did any substantial amount of trading in 2017.
- For tax purposes in the U.S., cryptocurrency is generally treated as property (a capital asset like stocks, bonds, and other investment properties). It is not treated like a currency, it is treated like real estate or gold. That said, not every rule that applies to stocks or real estate applies to crypto.
- Trading cryptocurrency to fiat currency like the dollar is a taxable event.
- Trading cryptocurrency to cryptocurrency is a taxable event (you have to calculate the fair market value in USD at the time of the trade; good luck with that).
- Using cryptocurrency for goods and services is a taxable event, i.e. spending cryptocurrency is a “realization event” (again, you have to calculate the fair market value in USD at the time of the trade; you may also end up owing sales tax).
- Buying cryptocurrency with USD is not a taxable event. You don’t realize gains until you trade, use, or sell your crypto. If you hold longer than a year you can realize long term capital gains (which are about half the rate of short term).
- Wallet-to-wallet transfers (where for example Bitcoin is sent from one Bitcoin wallet to another) are not taxable events. However, some exchanges may treat them as taxable for a safe harbor (so make sure to check their records against your own).
- Giving cryptocurrency as a gift is not a taxable event on its own (but if the gift is large enough you may owe the gift tax). The recipient of the gift receives essentially inherits the cost basis (so if you bought .1 BTC for $100, when the recipient sells or trades it they owe taxes on profits over $100).
- You owe taxes when you sell, trade, or use forked coins or coins you mined.
- Mining and using crypto as a business has unique considerations (see IRS guidance above).
- For 2017, it isn’t clear if you can claim like-kind property exchange (which would make it so you didn’t have to realizes gains and losses on trades). After December 31, 2017 1031 exchanges are limited to real estate. Thus, unless there is clarification you’ll owe taxes on all crypto trades in 2018 forward (but might be able to claim like-kind with the help of your accountant in 2017). See: Forbe’s Loophole Allows Tax-Free Bitcoin Exchanges Into 2018 for a breakdown of what may or may not be possible.
- To find out what you owe you have to tally up your gains and losses in a year and deduct this from your cost basis (good luck; most exchanges keep track of your trades, but not their value in USD, your accountant may use “reasonable estimates”). TIP: You can use your own records if you kept better records than the exchanges you used. Thus, one may want to keep their own record of every trade throughout the year noting time of trade, amounts in crypto, and dollar value.
- If you don’t know the exact fair market value at the time of a trade or use of cryptocurrency, use your best reasonable estimates.
- Moving the same coin between two wallets or exchanges shouldn’t be a taxable event, but you do have to account for it. Exchanges might treat these as taxable events by default, so make sure to not go off their records alone.
- FIFO rules should be optional. You should be able to choose between “First in First Out” FIFO and “Last in Last Out” LIFO.
- The wash rule likely doesn’t apply to crypto. Section 1091 wash sale rules only mention securities, not intangible property.
- There are loopholes in the new tax bill that let high frequency traders use a passthrough to benefit (essentially you would create an LLC for your trading). You have to be trading a good amount (in terms of volume and USD values) for this to work. See a professional for advice if you think this applies to you.
- You must make a good faith effort to claim your crypto and pay your taxes no matter which route you take.
- Trying to hide your assets is tax evasion, a federal offensive.
- Making a good faith effort, but getting it wrong, results in a fee.
- If you think you maybe might owe taxes from past years, file an amended return and get right with the IRS before they come looking for you. See: IRS Offers Tips on How to Amend Your Tax Return.
- When you file, be consistent. You can’t do FIFO over here, like-kind over there, wash rule here but not there, etc.
If you did anything other than hold, you should see a tax professional ASAP (a local CPA for example). The lack of clarification this year plus the Coinbase lawsuit hints at the idea that the IRS will have its eye out for traders who moved more than $20k in crypto. You must make a good faith effort if you moved more than $20k in crypto (even just between wallets). Further, you have some additional tax responsibilities if you make more than $1k in capital gains in a year (see below).
Do I owe taxes on cryptocurrency even if I never cashed out? Putting together all the above points, one may owe taxes on cryptocurrency even if they have never sold cryptocurrency for US dollars and never cashed out to their bank account. Remember, trading and using cryptocurrency are both taxable events where the taxable amount is calculated from the fair market value in U.S. dollars at the time of the event. So if you spent the year trading Bitcoin to Ethereum in GDAX or Bittrex, then you realized short term capital gains or losses with each trade and owe taxes on that.
How capital gains and losses work? All capital gains and losses realized in a tax year (Jan 1 – Dec 31) are weighted against each other and subtracted from your initial investment (your cost basis). Then you owe taxes on profits in that year. The short term rate is very similar to the ordinary income rate. The long term rate (on assets held over 365 days) is about half the short term rate. Long term gains can be realized at any point in any tax year via the above methods (by selling, trading, and/or using cryptocurrency). Please note that if you calculate your gains and losses as “first in first out,” you are realizing all your long term gains first (thus, you may want to see if “last in last out” works better for you). Lastly, on $3k in losses can be carried over between years (so if you have more losses than gains, you can only bring $3k worth forward each year to offset future gains).
How capital gains tax relates to ordinary income and the progressive tax system: Capital gains and ordinary income are both counted toward your adjusted gross income (income after deductions). Your adjusted gross income affects your tax bracket both in terms of ordinary income and capital gains. The U.S. has a progressive tax rate on ordinary income and capital gains, that means you pay progressively higher rates based on your adjusted gross income. You don’t just pay the top amount you qualify for on all dollars you earn, you pay the rate of each bracket you qualify for, on dollars in that bracket, for each tax type. If you don’t understand how progressive taxation works, see an explanation of the progressive tax system.
What form do I use to calculate gains and losses? Although it isn’t the only form you might need to file, Form 8949 Sales and Other Dispositions of Capital Assets is the form one would generally use to report capital gains and losses from selling, trading, and/or using cryptocurrency. Traders may also want to have Form 8824 Like-Kind Exchanges on hand.
What other forms do I need to file for cryptocurrency? Aside from the above forms, some also might need Form 4684 Casualties and Thefts (if for example they had a hard drive that stored crypto damaged in a hurricane, form 2210 for underpayments of quarterly taxes (explained in the next section), and Form 8938 Statement of Foreign Financial Assets if you used a foreign exchange. See: Golding & Golding’s Understanding the Rules of Bitcoin Reporting for FBAR & FATCA.
When do I pay taxes on crypto gains, do I Have to file quarterly for crypto trading? In general the U.S. has a pay-as-you-earn tax system. When you get your check from your job, taxes are withheld. When you run a business, you pay quarterly taxes. When you make enough capital gains, it is the same deal. If you would owe more than $1,000 in taxes at the short and/or long term capital gains tax rate for the year, then you should be making quarterly payments. If you wouldn’t owe more than $1,000, you can make an annual payment instead. If you have to file quarterly, then you need to use your best estimates. If you overpay or underpay, you can correct this at the end of the year. There is a fee for not making estimated quarterly payments when required, and if you underpay too much there is a fee for that too. See: Large Gains, Lump Sum Distributions, etc and Publication 505 (2017) Tax Withholding and Estimated Tax. If you overpaid, make sure to read up on: Form 2210 Underpayment of Estimated Tax by Individuals, Estates and Trust. NOTE: To owe $1,000 in capital gains you have to make enough profit to realize $1,000 over the course of a year at your tax rate. Profits are not the same as the gross dollar amount traded, profits are calculated from all capital gains and losses in a year.
You must make estimated tax payments for the current tax year if both of the following apply: 1) You expect to owe at least $1,000 in tax for the current tax year after subtracting your withholding and refundable credits, and 2) You expect your withholding and refundable credits to be less than the smaller of: a) 90% of the tax to be shown on your current year’s tax return, or b) 100% of the tax shown on your prior year’s tax return. (Your prior year’s tax return must cover all 12 months.)
TIP: It can make life simple to cash out before midnight on December 31 and start again next year (as that would ensure all gains and losses are set in stone before the end of the tax year). Likewise, going all in on a crypto you don’t currently hold essentially has the same effect (if you treat crypto-to-crypto as a taxable event). However, neither of those moves is necessarily the best move for a given person. Those moves potentially hit the reset button on one hand, ensuring all the years gains and losses stay in that year, but realizes all gains and losses with the other (meaning you are no longer “going long” on any crypto investments). The problem here is that if like-kind applies, then cashing out limits your options. It stinks that there was a serious lack of clarification this year, but it is what it is. Play it safe and see a professional before you go panic selling or trading due to tax implications. In general, if you are unsure, then do what you would do if there were no tax implications and be ready to pay taxes on profits.
WARNING: If you make great gains this year on-paper and traded crypto to crypto or crypto to dollars, but then crypto goes to heck next year, you could end up owing a ton of money to the IRS you don’t have. You could run into real problems if crypto goes to zero (very unlikely) or if you panic and sell low. Seek guidance from a professional before making rash moves. Like-kind rules could potentially get you out of a mess like the cases noted above, but you’ll need to file forms and attest to a very specific situation. You can’t do this alone, you must seek professional assistance. Even if you do file like-kind, the IRS can be like “nope” and send you a bill. Don’t put it “all on crypto” if you don’t have the fiat to cover the tax implications. But remember, if you are already in crypto, going to USD before the end of the year means for sure you are realizing gains and losses. There are way more considerations than there is time, next year make sure you are prepared well in advance. Fingers crossed the IRS bothers to provide guidance beyond the 2014 guidance moving forward (with the 1,000%+ rise in the price of crypto assets and all… it would only make sense).
- the Official IRS Guidance from 2014
- IRS Publication 544
- Bitcoin Tax Guide: Gifts And Tips. TurboTax.com.
- The Gift Tax.Investopedia.com.
- Loophole Allows Tax-Free Bitcoin Exchanges Into 2018. Forbes.com
- Golding & Golding’s Understanding the Rules of Bitcoin Reporting for FBAR & FATCA. GoldingLawyers.com.