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 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 – 2018.
A Summary of Cryptocurrency and Taxes in the U.S.
- For tax purposes in the U.S., cryptocurrency is treated as property (a capital asset like stocks, bonds, and other investment properties). It is not treated as 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 a 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.” 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).
- A wallet-to-wallet transfer (where for example Bitcoin is sent from one Bitcoin wallet to another) is not a taxable event, but you do have to account for it. Be aware that some exchanges may treat wallet-to-wallet transfers as taxable as 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 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. Generally speaking, a forked coin would have a cost basis of $0 (you paid nothing for it), a mined coin would have the cost basis of its dollar value at the time of mining (its value in USD at the time it was recived).
- Mining and using crypto as a business have unique considerations (see IRS guidance above). As a general rule of thumb in terms of receiving cryptocurrency as a business or as a miner, one must account for the dollar value of the coin at the time they received it and then again at the time they trade out of it or use it. If you pay someone in crypto you’ll need to report that as well (for example if you pay an employee in crypto or if you pay a contractor over $600 worth of crypto). Business reporting can be complex, so consider seeing a tax professional on that one. Assume receiving crypto as a miner or business is a taxable event.
- For 2017, it isn’t clear if you can claim like-kind property exchange (which would result in you not having to realize 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 and forward (but might be able to claim like-kind with the help of your accountant in 2017). See Forbes 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 at the time of the trade (which is information you need).
- If you don’t know the exact fair market value at the time of the trade or use of cryptocurrency, use your best reasonable estimates. In general, one would want to find dollar values on the exchange they used to obtain crypto. If you didn’t use an exchange, then consider using the dollar value on an exchange you would have used (be wary of using average dollar values from multiple exchanges, as you’ll be factoring in exchange you couldn’t have used). Make sure to be consistent in how you track dollar values. TIP: Consider keeping your own records. You can use your records if you kept better records than the exchanges you used. Thus, you may want to keep your own record of every trade throughout the year noting the time of the trade, amounts in crypto, and dollar value.
- FIFO rules should be optional. You should be able to choose between “First in First Out” FIFO and “Last in First Out” LIFO (and potentially a few other calculation methods, check with your CPA). Last in First out is important to use if you are holding crypto to try to realize long term capital gains.
- 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 passthrough businesses to benefit (essentially you would create an LLC for your trading). You have to be trading a good amount (in both 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.
Cryptocurrency and Taxes Q&A
Below are some questions and answers pertaining to cryptocurrency and taxes.
There is crypto tax software that can potentially help. There are a number of crypto tax software solutions to be found online. In general you need to pay a fee to use the software then give the software READ ONLY access to your trading history via an exchange’s API, import data from a CVS file, or enter it by hand (you can also give it access to wallet data). This can produce something your account can work with (the raw transaction data isn’t going to have dollar values and this could, understandably, be too much for your CPA to handle). I have reviewed one option Cointracking.info (click this link for a review), but here is how you search for more of them to research yourself: “name of exchange + tax calculator” or “cryptocurrency tax software.” You will need to double check the software’s work against your own records, but for those who did a lot of trading this sort of software could be a necessity (figuring out fair value USD for many trades is next to impossible, the software even with all its headaches… is likely to save you a headache).
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 on GDAX or Bittrex, then you realized short-term capital gains or losses with each trade and ow 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 (or you realize losses). You aren’t double taxed, it doesn’t matter if you did countless small trades or one big trade, capital profits and losses work the same way, the only difference is the amount of work it takes to do your reporting. 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, or using cryptocurrency). Please note that if you calculate your gains and losses as “first in first out,” you realize all your long-term gains first (thus, you may want to see if “last in first 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 for both 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 use to report capital gains and losses from selling, trading, 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? You might also need Form 4684 Casualties and Thefts (if for example, you 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? 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 in the short 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 crypto that you don’t currently hold has a similar effect (if you treat crypto-to-crypto trades 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 the one hand, ensuring all the year’s gains and losses stay in that year, but realizes all gains and losses on the other hand (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. The lack of clarification doesn’t help for planning ahead, 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.
What other forms do I need to file for cryptocurrency? You might also need Form 4684 Casualties and Thefts (if for example, you had a hard drive that stored crypto damaged in a hurricane; Form 2210 Underpayment of Estimated Tax by Individuals, Estates and Trusts 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..
On Cryptocurrency Mining and Taxes: When you mine a coin you have to record the cost basis in fair market value at the time you are awarded the coin (that is profit on-paper). Then you account for further profits or losses when you sell that coin (so as long as you sell it within the year, you can’t owe more than you made if the value of the coin goes down). From there, as long as you are making enough to qualify as being self-employed and not mining as a hobby, you can deduct the cost of equipment and electricity, and then you pay taxes on the profit. In general you owe the self-employment tax if you make over $400. If you made over $400 and would owe the self-employment tax, it is reasonable to consider yourself self-employed for the purposes of mining and file that way. Just make sure to follow the rules presented by the IRS. See: IRS Self-Employed Individuals Tax Center, Can I Deduct Mining Costs?, What you Need to Know About Bitcoin Mining and Taxes, and the above IRS guidance on cryptocurrency (it includes a section on mining).
On Cryptocurrency and Business: Generally speaking, getting paid in cryptocurrency is like being paid in gold. It is income in the form of an investment property. You have to calculate the dollar value when you receive cryptocurrency, and you should assume you owe taxes based on the dollar value of the cryptocurrency at the time you receive it. Later, you would calculate dollar values again when you trade out of cryptocurrency (by trading, selling, or using it) and account for profits/losses at that time. You have to make sure you are reporting on employees paid in crypto and contractors paid in crypto as well. Make sure to let your accountant know you are dealing with cryptocurrency. Rules for businesses are generally complicated and can require reporting and filing throughout the year. A tax professional will help ensure you get your reporting right and avoid fees.
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 say “no” 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 that you realize 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.
- Golding & Golding’s Understanding the Rules of Bitcoin Reporting for FBAR & FATCA. GoldingLawyers.com.