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][5]

The above are the basics, we’ll go over all the more complex factors below.

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.

The Basic Tax Implications of Cryptocurrency (Unless you “Just HODL” You Almost Certainly Owe the Short Term Capital Gains Tax)

Here is the bottom line on cryptocurrency and taxes in the U.S. for investors/traders (it can be gleaned from the official IRS guidance from 2014; you’ll need to reference Publication 544 as well):

  • 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),
  • Using cryptocurrency for goods and services is a taxable 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).

Essentially, anything other than holding cryptocurrency is a taxable event (meaning you have to realize capital gains and losses when you trade, sell, or use crypto).

This means you and your accountant are up against a lot of work and best estimates this tax season if you did even a moderate amount of trading.

This means you’ll need to be prepared to pay capital gains taxes (thus you will need fiat currency at tax time).

And yes, this means if you make a lot of gains this year, but then lose them before tax time, you’ll owe the IRS a bunch of money you don’t have (unless you and your accountant can make a specific and reasonable case otherwise; although this might not work).

We will cover basic exceptions and grey areas below.

NOTE: Above is the gist of cryptocurrency and taxes. We aren’t tax professionals though, so you’ll need to do your own research (and will likely want to hire yourself an accountant if you made any substantial profits in crypto from trading). For a more concise take, see: The Tax Rules for Crypto in the U.S. Simplified.

Can I Claim Like-Kind Property Exchange For CryptoCurrency?

With all that said, there are some sort of grey areas to consider for 2017.

First off, there been some confusion over like-kind property exchange (or more generally, the ability to claim a crypto-to-crypto trade as being of “like-kind” and thus crypto-to-crypto trades not being a taxable event).

In short, it isn’t fully clear if the taxes owed on profits from trading one cryptocurrency for another can be negated by claiming like-kind property exchange (i.e. it isn’t 100% clear if one can use like-kind property exchange rules to defer paying taxes on cryptocurrency until it is converted into USD or another currency).

To claim like-kind property exchange you must have a tax professional guide you. You’ll need to file forms, claim like-kind, make a good faith effort, and officially state you are calculating this way.

I would note that the IRS guidelines say:

“the character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer.”

If you treat all of your crypto as a single investment in crypto, a single capital asset, or if you consider Ethereum to be in “like-kind” to Bitcoin for example, maybe just maybe you can justify not realizing capital gains in crypto-to-crypto trades… for 2017 only.

Or, more specifically, if you treat your crypto like an investment property to which rules for Nontaxable Exchanges should apply, claiming they are like-kind, then maybe, maybe, maybe this might be sort of reasonable.

Like-Kind Exchange in 2018 and Beyond

Unfortunately, even if like-kind applies for 2017, in 2018 the new tax bill bans all like-kind exchanges that aren’t related to real estate.

Thus, moving forward like-kind is off the table unless the IRS offers clear guidance otherwise.

Also, since the tax bill does away with like-kind in 2018, it calls into question the use of like-kind in 2017.

Still, a professional might be able to help you make a case for like-kind in 2017 if you have treated crypto as an investment property and you can make a reasonable case for it (please note that you cannot do this yourself, you must hire a professional).

See: Forbe’s Loophole Allows Tax-Free Bitcoin Exchanges Into 2018 for a breakdown of what may or may not be possible.

Other Rules to Consider

Moving on, there is more to this if you do end up paying capital gains taxes. Specifically, 1. the wash rule does not apply (Section 1091 wash sale rules only mention securities, not intangible property; although you could perhaps make a case for it when you file) and 2. one should be able to choose between FIFO (First in First Out) and LIFO (Last in Last Out).

In Short, Get Ready to Pay Taxes on Capital Gains and Hire a Tax Proffesional

In short, this means if you trade, you have some flexibility and long shots, but you likely have no way around realizing a good chunk of capital gains.

This makes preparing for the tax season incredibly complex and trading cryptocurrency rather risky and somewhat lackluster the U.S..

Anyone who did substantial crypto-to-crypto trading should see an accountant and make a “good faith effort” to report their holdings accurately and pay taxes.

Messing up a good faith effort could result in fines… but not making a good faith effort could be seen as tax evasion. Paying a fee is not the worst thing in the world, going to federal prison for tax evasion isn’t great.

In the meantime, since there is so much not known for sure, as a safe harbor, one should assume they are paying taxes of profits from crypto-to-crypto trades and that each trade from crypto to fiat and fiat to crypto is a taxable event for the calendar year (the tax year).

Here I’m not saying that crypto-to-crypto trades will be treated as taxable events, I am only saying that unless you have talked to an accountant and have a game plan for how you will account for your crypto, you should prepare for the worst and make sure you have a plan B that includes paying taxes on profits from crypto-to-crypto transactions.

That said, if you are going to covert to USD to pay taxes (if for example you are “all in” on crypto, and thus will need to cash out some crypto to pay taxes if and only if crypto-to-crypto trades are taxable), you should really talk to an accountant first and may want to wait until Jan 1st (the start of the new tax year) to cash out.

Or, if you want to realize losses and know you won’t claim like-kind, you may want to take a loss this year on paper (to lower your taxable income).

The right thing for you depends on your specific situation. If you traded, your situation is complex. Thus, thus you need to see a professional for advice ASAP before the end of the year ideally.

To sum up that last part:

  • If you convert from crypto to fiat and keep your cash in fiat in this tax year, then clearly we know that is taxable. Thus you can get in this situation where the funds you cash out are themselves subject to a tax (and it sort of opens up a rabbit hole).
  • Meanwhile, and this is good news for holders, if you bought cryptocurrency and held it, you don’t pay taxes until you trade it for fiat or another crypto.

Lastly, remember, hiding your crypto assets and not paying your taxes could at best end up with you owing fees, interest, and missing out on some deductions… and at worst can be seen as tax fraud and tax evasion. You don’t want that. See “what happens if I don’t pay my taxes.”

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

TIP: If you are confused, you should be. The IRS has made very little effort to clarify the rules, and the tax bill only made the situation worse for most normal people. That may make you feel like “it is on them.” However, it is not “on them” it is on you, your taxes are your responsibility. Thus, you are in for a bit of a nightmare and you lack allies outside of your paid tax professional (you must seek professional advice or you risk a lot here).

TIP: The one exception to the tax bill putting you in a bad place is: if you are an LLC, list yourself as a trader, and meet certain criteria (mostly related to your income) the tax bill can work in your favor a bit. You might want to consider this for 2018.

NOTE: If you make very little money outside of trading, and you didn’t make that much trading, then you won’t owe that much if anything. This is due to the way the progressive tax system works. If you are somewhere in the middle, there are many more considerations.

NOTE: As noted FIFO rules should be optional in cryptocurrency. Learn more about cryptocurrency and FIFO.

TIP: The long term capital gains rate is lower than the short term rate. Between that and the accounting nightmare, one can see why holding crypto long can be a real benefit in terms of taxes. In the U.S. it is hard to trade effectively enough to offset all the negative effects.

NOTE: To qualify for like-kind property exchange, you have to file your taxes and file the 8824 form that claims like-kind property exchange. So not only is no one sure if this is an option, but further, it being an options requires filling out a form, claiming all your crypto assets, and filing your taxes. We say this a few times on the page, but let us stress it here: see an accountant before the end of the fiscal year if you made profits in crypto. Don’t try to be a hero and figure this all out yourself unless you know what you are doing.

TIP: You should assume the IRS knows your trading history. They want their taxes on your Bitcoin Cash, Bitcoin, and other cryptocurrency profits (if you made money from a fork, that is if you got forked coins and sold them; make sure to pay your taxes). Don’t think you can get away with tax fraud. That is a dark road to head down, you could well be made an example of. Right now entities like Coinbase are fighting to protect your transaction history, but be aware that there is little chance that the IRS is going to let the gains this year go by without collecting their due. Don’t risk federal prison, pay your taxes. See the ruling of the United States v. Coinbase (it was at best a partial victory).

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:[6]

  • The rules about cryptocurrency and taxes are murky at best. Does cryptocurrency follow like-kind exchange rules, or does it not like currency? For now one should assume it doesn’t (and thus there is no way around paying taxes on profits realized at the time crypto-to-crypto trades are made), but the truth is there is no crystal clear direction on this yet. That is just one of many unanswered 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 to 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. The like-kind form would give you a way to get around this if it works, but that is looking less and less likely as the year rolls on.
  • 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). Meanwhile there are some specific rules that apply when using crypto for transactions and not just as an investment.
  • When you spend a Bitcoin or other crypto, for example on a good or service, that is a “realization event” (same as trading crypto to crypto or crypto to fiat). At that point you owe the capital gains tax on the fair market value of the goods or services provided. So if you bought $100 worth of pizza for 1 bitcoin, and you bought the bitcoin for $110, you lost $10 and would tally that loss (or, if you paid $10 for the Bitcoin, you realized $90 in gains and would tally that). When buying goods and services you may also owe other taxes like the sales tax. Likewise, if you use crypto in business you could owe other taxes (like payroll or state and local taxes) as well.
  • 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.” That means you’ll need to deal with short and long term capital gains and losses (and make sure you are paying the appropriate rates and writing off capital gains against capital losses the right way).

With the above core points noted, the following is a list of keys to making sure you understand the basics of cryptocurrency and taxes: Read the IRS regulations below (and keep an eye out of updates), understand that crypto is generally treated as an investment property and subject to the short and long term capital gains tax (thus the rules for investment properties generally apply), understand that capital gains count toward your total taxable income (and affect your tax bracket), understand how independent capital losses and capital gains in a year can be written off against each other, understand “the wash rule,” understand the difference between long term and short term capital gains, understand that one should treat all exchanges from one crypto to another or crypto to USD as a taxable event (calculated based on the value of the trade in USD at the time). DON’T WAIT TO FIGURE THIS OUT. You’ll need some time to get your accounting sorted out and may want to conduct some transactions before the end of the calendar year to end the year in a favorable situation in terms of taxes. Only a small amount of capital losses can be carried over in-between years! This is all explained in more detail below.

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.[7]

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 – A Retraction and New Position Published by David Klasing at September 1, 2017 or Cryptocurrency Traders Risk IRS Trouble With Like-Kind Exchanges.[8][9]

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.

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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. thetaxadviser.com. Cryptocurrency and Taxes
  6. 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
  7. IRS Virtual Currency Guidance : Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply
  8. Virtual Currency and Section 1031 – A Retraction and New Position Published by David Klasing at September 1, 2017
  9. Cryptocurrency Traders Risk IRS Trouble With Like-Kind Exchanges