By Cryptocurrencies like bitcoin and ethereum have grown in popularity in recent years. This growth has drawn the attention from governments around the world, and in the US particularly, the IRS recently announced that the taxation of cryptocurrency is one of its top 5 priorities for the year. This has a lot of traders and tax professionals asking the question – How is cryptocurrency taxed?
Depending on what country you live in, your cryptocurrency will be subject to different tax rules. The questions below address implications within the United States, but similar issues arise around the world. As always, check with a local tax professional to assess your own particular tax situation.
Crypto Tax Implications
As stated in the official guidance put out by the IRS in 2014, cryptocurrency should be treated as property for tax purposes, not as currency.
This means that cryptocurrency is subject to capital gains and losses rules similar other forms of property like stocks, bonds, real estate, gold, etc. In other words, you need to report your gains and losses for all of your cryptocurrency transactions and investments on your taxes.
An Example
Let’s say you buy 0.25 bitcoin for $3,000 in April 2019.
If you simply buy and hold this cryptocurrency, you do not owe any taxes until you realize a taxable event (like the sale or trade of your crypto).
Now let’s say three months go by, and you sell this 0.25 bitcoin for $5,000.
In this scenario, you have incurred a $2,000 capital gain on the sale of your bitcoin.
This sale triggers a taxable event, and you will need to report this gain on form 8949 of your tax return for your cryptocurrency taxes.
What about crypto-to-crypto trades?
When you trade one cryptocurrency for another, this also triggers a taxable event that you will need to report on your taxes. In this scenario, the capital gain/ loss calculation is not as easy because your trades are not quoted in US dollars or other FIAT currency.
Let’s review the capital gain/ loss equation:
Fair Market Value – Cost Basis = Capital Gain / Capital Loss
What is Cost Basis?
Cost Basis is the original value of an asset for tax purposes. In the world of crypto, your cost basis is essentially how much it cost you to acquire the coin.
What is Fair Market Value?
In the simplest sense, fair market value is just how much an asset would sell for on the open market. Again with cryptocurrency, this fair market value is how much the coin was worth in terms of US dollars at the time of the sale.
Example
So now let’s say you traded 0.25 bitcoin for 20 Ether instead of selling it for dollars. In this case, you still trigger a taxable event that needs to be reported; however it’s a bit harder to calculate your fair market value because you did not sell for dollars.
So in this case, the fair market value is whatever 0.25 bitcoin or 20 ETH was worth at the time of the transaction.
Your cost basis was $3,000, and this is what you paid for the 0.25 bitcoin initially.
Your fair market value is $5,000 which is what 0.25 bitcoin or 20 Ether was worth at the time of the trade.
Your capital gain is $2,000, and you would pay a percentage of that gain in bitcoin taxes.
If you have a high number of cryptocurrency trades, these calculations can become difficult to do by hand.
What if I lost money trading cryptocurrency?
Many traders lose money when trading crypto. These losses are still required to be reported on form 8949, and they will actually reduce your taxable income and save you money on your tax bill.
Whenever your total capital gains and losses for the year add up to a negative number, you incur a net capital loss. If the net capital loss is less than or equal to $3,000 ($1,500 if you are married and filing a separate tax return), then that entire capital loss can be used to offset other types of income—like the income from your job.
If your losses exceed $3,000, then the amount over $3,000 will be rolled forward to the next tax year.
Cryptocurrency Mining
For tax purposes, mined cryptocurrency is treated as regular income at the time it is mined. You should use the fair market value of the cryptocurrency at the time it was mined to determine the amount of income received.
In Conclusion
Crypto taxation is not extremely complicated. As long as you keep track of your investments throughout the year and are aware of the tax implications, you will easily be able to stay compliant.
*This post is for informational purposes only and should not be construed as tax or investment advice. Please speak to your own tax expert, CPA or tax attorney on how you should treat taxation of digital currencies.
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