This article was published March 15, 2018. Any events or information released subsequent to that date would not be reflected within it.
Imagine finding out you owe the Internal Revenue Service $50,000 because of some ill-timed cryptocurrency trading. That’s just what happened to one Reddit poster who pleaded for guidance on the forum.
The problem is likely not uncommon given the recent meteoric rise and fall of cryptocurrencies in the months straddling the New Year. For instance, Bitcoin’s value was on the rise all of last year but kicked into high gear in mid-November, skyrocketing 258% in value through mid-December. Since the beginning of the year, its value has dropped 41%. Other cryptos saw similar ups and downs.
Anyone who invested in digital currencies and sold for a profit last year likely must pay a capital gains tax to Uncle Sam this year. This is especially painful if you reinvested gains from last year but got hammered by the cryptocurrency downturn this year, losing major money like the Reddit poster. Not only are you stuck with a huge capital gains tax bill, but you also have to pay it after losing your previous gains.
Here’s what you should know, no matter how your digital currency investments performed.
Your tax obligations
Since 2014, the IRS has considered Bitcoin and other cryptocurrencies to be capital assets, and they must be treated as property for tax purposes. As with stocks or bonds, any gains or losses from the sale or exchange of Bitcoin or other virtual currency are taxed as capital gains or losses. Net capital losses up to $3,000 can be deducted in a given tax year, and anything over that amount can be carried over into future tax years.
So far, the IRS hasn't ruled on whether cryptocurrencies can benefit from a like-kind exchange, says Mike Slack, lead tax research analyst at The Tax Institute at H&R Block. This allows the sale of an asset and the acquisition of another, similar asset without incurring any tax liability from the sale of the first.
Figuring out what you owe is complicated, though, when it comes to cryptocurrency. Typically, banks and brokerages will send a type of 1099 tax form to individuals to report earnings not found on your W-2 such as dividends or proceeds from securities transactions. But most exchanges where individuals trade virtual currencies don’t provide these forms to help with tax reporting.
Coinbase is somewhat of an exception. It generates a Form 1099-K for investors who received at least $20,000 in proceeds from cryptocurrency sales in at least 200 transactions during the year. But if you don’t meet that criterion — like many part-time investors — you must use your account transaction history to calculate your gains (or losses). Coinbase, unlike most other currency exchanges ValuePenguin checked out, provides a report showing the price of each purchase and the proceeds of each sale to help with filing your taxes.
DIY tax reporting
Aside from the tools listed above, you’re on your own to figure out your tax obligations. Here are some tips for how to go about it.
- Don't forget to include transaction fees in the cost basis of each investment. If you paid a fee to an exchange to buy your cryptocurrency — such as the 3.99% fee Coinbase charges for credit card transactions — then your original investment was that much more expensive, lowering your taxable gains.
- If you have too many transactions to handle yourself, turn to Bitcoin.tax or Cointracking.info, which will tell you what to input in your Schedule D based on your trading history. These services may charge a fee if you exceed a certain number of transactions.
- If self-reporting seems too daunting, seek the advice of an accountant or tax advisor to make sure you file and pay the correct amount in taxes.
- Don't try to hide trades from the IRS, as it will only complicate tax reporting in future years, when the IRS has better visibility into your assets.
- To be prepared, set aside money each time you make a taxable trade to compensate for the tax associated with that transaction. Your long-term capital gains tax is determined by your tax bracket.
Tax bracket for 2017
Capital gains tax
|0% or 15%||0%|
- For future tax reporting, keep records of your virtual currency transactions. Record the dates and market value when you earn, buy or exchange currency and the date and sales proceeds when you sell, exchange or spend the currency.
Other tax consequences involving cryptocurrency
Investors aren’t the only ones who face tax implications over cryptocurrency. Any place of business or independent contractor that accepts cryptocurrency for goods or services must include its dollar value in the business’s or self-employed person’s gross income. If your employer paid you in cryptocurrency, those wages are subject to the same withholding and must be reported in your total W-2 wages as dollars.
If you have successfully mined Bitcoin or other virtual currencies, the IRS considers the receipt of that currency as gross income, and it should be included in your tax return as such. Again, the dollar value of the cryptocurrency is based on market value. If you mine for digital currency as your own business, then the net earnings from that — gross income minus allowable deductions — are subject to self-employment tax.
In these cases, the dollar value of the cryptocurrency is based on the digital currency’s market value at the date of payment. If the cryptocurrency, such as Bitcoin, is traded on an exchange, that rate can be used to determine the value.