How Do Taxes Work With Cryptocurrency? – Paying Taxes on Cryptocurrency in the United States

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 as currency like the U.S. dollar. That means it is teated like real estate or gold in most cases, and thus it is subject to the short and long term capital gains tax in most cases when held for investment (if used for transactions, as an individual or business, then other rules can apply; see official IRS guidance and state guidance below).[1][2][3][4]

With that said, there has been some confusion or like-kind property exchange. In short, it isn’t fully clear if trading one cryptocurrency for another is a taxable event for the year (or if one can defer paying taxes on cryptocurrency until they convert it to USD or another currency).

With that in mind, we cover the basics of cryptocurrency and taxes below alongside some insight into some still unanswered questions.

TIP: We aren’t tax professionals and as such don’t offer professional advice. Below is just a collection of information pertaining to cryptocurrencies like BitCoin, LiteCoin, and Ethereum regarding taxes. We strongly suggest having an accountant assist you in reporting capital gains from cryptocurrency.

TIP: This page is meant as a general overview. For official documents related to the IRS, cryptocurrency, and taxes see: Sales and Trades of Investment Property, Like-Kind Exchanges Under IRC Code Section 1031, and IRS Virtual Currency Guidance : Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply.

Key Facts About Cryptocurrency and Taxation in the United States and in General

With that introduction in mind, here are the key points to understand about cryptocurrency and taxes:[5]

  • The rules about cryptocurrency and taxes are murky at best. Does cryptocurrency follow like-kind exchange rules like stocks, or does it not like currency? For now one should assume it doesn’t, but the truth is there is no clear direction on this yet. That is just one of many answered questions here in 2017. If you had any substantial activity in the cryptocurrency space, consider hiring an accountant to help you square up with the IRS at tax time.
  • Trading cryptocurrency is a taxable event (and so is using it in any way). That means every transaction (between cryptocurrency and cryptocurrency, cryptocurrency and fiat currency, or cryptocurrency and goods and services) needs to be recorded and appropriate taxes need to be paid.
  • Cryptocurrency is treated as property for tax purposes. This is true whether you are holding cryptocurrency as an investment, using cryptocurrency as a payment method (for buying goods and services or for employee compensation), mining cryptocurrency, or treating cryptocurrency as inventory (if say you are in the odd position of acting as a cryptocurrency retailer). Despite this, some
  • Cryptocurrency is generally subject to capital gains taxes (and you should report it as such to the IRS), but¬†like with other investment properties, the tax implications can differ depending on how the property is treated “in the¬†hands of the taxpayer.”

TIP: Paying someone with cryptocurrency is like paying someone in gold, trading one cryptocurrency for another is like trading gold for silver (although there is a real possibility the rules of “like-kind exchange” don’t apply), buying cryptocurrency as an investment is like buying gold as an investment, mining cryptocurrency is like mining gold (you have to pay taxes on it), and retailing in cryptocurrency (where you hold cryptocurrency as inventory in a store) is like retailing in gold. For tax purposes then, cryptocurrency can be thought of as digital gold (not as digital currency).

TIP: Each country has their own rules for cryptocurrency. The rules on this page apply to the United States specifically, so make sure to check out the rules of other countries if paying taxes somewhere else.

Looking to the IRS Guidance on Cryptocurrency

The best way to understand the specifics of the tax implications of cryptocurrency is to understand IRS Notice 2014-21, which provided guidance for paying taxes on cryptocurrencies like Bitcoin.[6]

The report says:

——- From the IRS Virtual Currency Guidance : Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply ——-

Virtual currency is treated as property for U.S. federal tax purposes.  General tax principles that apply to property transactions apply to transactions using virtual currency.  Among other things, this means that:

  • Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
  • Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. ¬†Normally, payers must issue Form 1099.
  • The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
  • A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

——- End IRS¬†——-

FACT: The above guidance isn’t the only document you need to consider. Also important is a¬†31-page report from the Treasury Inspector General for Tax Administration¬†released Sept. 21, 2016.

TIP: Some states have specific state-based rules, for example Washington and New York (this is mostly rules for those who wish to operate an exchange, but there are also rules that could apply to individuals and businesses using cryptocurrency). Everyone should take the time to brush up on rules for their state, especially if they will be reporting state taxes (and not just federal).

TIP: For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars.

TIP: If you mine cryptocurrency you have to pay taxes on the coins you mine and you’ll generally owe the money as self-employment income and be subject to the self employment tax.

The Tax Implications for the Average Cryptocurrency User

Putting aside the employer end of things and focusing on the average Bitcoin user, the tax implications of the above are:

  1. If you trade cryptocurrency for a good or service, trading a cryptocurrency for a video game for example, then you need to keep a record and report every transaction, reporting fair-market value of the currency at the time of the transaction. Or in the words of the IRS: “A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.”
  2. If you trade cryptocurrency as a capital asset, either for another cryptocurrency or for fiat currency (like the US dollar), you need to keep a record and report those transactions (using the fair-market value of cryptocurrencies in cases where one cryptocurrency is traded for another). Then at the end of the year, you need to report all cryptocurrency transactions, and all the related gains and losses (and all transactions), and then pay taxes based on your total gains.

Ex. If you trade Litecoin for Bitcoin, that is a transaction that needs to be accounted for by reporting the fair-market value in US dollars at the time of the transaction. Likewise, if you trade Bitcoin to USD, that is a transaction that needs to be accounted for.

That brings us to a somewhat complex note with somewhat complex implications regarding “like-kind exchanges of like-kind property.”

WARING – Cryptocurrency and like-kind property exchange: In general one should assume the rules of “like-kind property” or “like-kind 1031 exchange” do not apply to cryptocurrency. In simple terms, this means that you can’t trade one cryptocurrency for another and defer gains and losses year-to-year that way. For example: you can’t buy a bitcoin in 2017, trade it to litecoin in 2017, sell the litecoin in 2018, and then pay taxes then. You have to pay taxes each time a cryptocurrency is converted into another currency. This can have some complicated tax implications where you can end up owing on profits in one year, but see those gains wiped out the next year, and then are unable to write off gains against losses because you are dealing with separate investments in separate tax years! In other words, you could, in the worst case, lose all your money and still get a giant tax bill if you trade a lot of cryptocurrencies over the course of a two year period with heavy gains one year and heavy losses the other. If you are going to trade cryptocurrencies, consider every trade from cryptocurrency to cryptocurrency, or from cryptocurrency to USD, as its own transaction for tax purposes (each transaction from one coin to another is a taxable event where the fair-market value of profits and losses must be calculated in USD). You can write of capital gains and losses in a year (writing off real estate, against gold, against one cryptocurrency, against another cryptocurrency for example), and things like the 30-day rule (and other such rules) should by all means apply, but you can’t treat different cryptocurrencies as “like-kind properties” and defer gains and losses into another calendar year that way. If you don’t understand that warning, but do trade currencies, take the time to brush up on 1031 exchange rules and cryptocurrency. Essentially, you need to be very careful about trading from one calendar year to the next without consulting a tax professional due to the volatility of cryptocurrency. For the pro version what we are talking about, see:¬†Virtual Currency and Section 1031 ‚Äď A Retraction and New Position Published by David Klasing at September 1, 2017¬†or¬†Cryptocurrency Traders Risk IRS Trouble With Like-Kind Exchanges.[7][8]

Bottomline on like-kind exchange: Even though the IRS said cryptocurrency is a property, some are speculating that it will be treated like a currency in terms of like-kind exchange (that is, that the rules of like-kind exchange won’t apply). Until we know for sure, assume the rules don’t apply.

Citations

  1. How Bitcoins Are Taxed The tax implications of bitcoins and staying organized
  2. IRS Virtual Currency Guidance : Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply
  3. Sales and Trades of Investment Property
  4. Like-Kind Exchanges Under IRC Code Section 1031
  5. Cryptocurrency and taxes A John Doe summons from the IRS to Coinbase is the latest development in the IRS’s attempt to deal with these new forms of currency. By Craig W. Smalley April 20, 2017
  6. IRS Virtual Currency Guidance : Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply
  7. Virtual Currency and Section 1031 ‚Äď A Retraction and New Position Published by David Klasing at September 1, 2017
  8. Cryptocurrency Traders Risk IRS Trouble With Like-Kind Exchanges