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Explainer Culture

How to handle cryptocurrency on your taxes

You sold some bitcoin. Now the IRS wants its cut.

Before you jump into this explanation of how cryptocurrency affects your taxes, check out our first article in this series: Bitcoin, explained.

It's been a wild ride for cryptocurrency enthusiasts over the past few months. 

After ascending to a high water mark of $19,205 in December 2017, the world's preeminent cryptocurrency -- that's bitcoin -- shed more than half its value over the 60 days that followed. (As of mid-February, it's climbed back past $10,000.) Other virtual currencies, including Litecoin and ether, also saw precipitous drops.

Now, in the wake of that dramatic swing, it's time to start thinking about taxes. 

The freewheeling universe of cryptocurrencies has so far mostly evaded the cumbersome, complex regulations customary in most other US financial markets. That's likely to change in 2018, however, given the SEC's closer scrutiny of virtual currencies. In fact, a number of state and federal agencies are increasingly concerned about the individual and systemic risks cryptocurrencies pose. Those range from good old-fashioned fraud to more novel cybercrimes, as well as the distinct possibility the government has forfeited massive amounts of tax revenue to this secretive market since 2013.

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The chairmen of the US Securities and Exchange Commission and Commodity Futures Trading Commission testified at a Senate hearing about virtual currencies in January.

Senate.gov

The attention is likely warranted. An SEC lawsuit filed against Coinbase last year revealed that fewer than 900 taxpayers reported gains related to bitcoin between 2012 and 2015, even though more than 14,000 Coinbase users recorded transactions of $20,000 or more during the period.

While legislators ponder new rules, and regulators consider how existing ones might apply to this new realm, the IRS has already made itself pretty clear: you have to pay taxes on cryptocurrency. But, like everything associated with the blockchain in 2018, the nascent branch of crypto tax law is very much a work in progress.

Read: The IRS guidance on cryptocurrencies

So, if you bought -- and more importantly, if you sold -- bitcoin or any other cryptocurrency in 2017, read on. April 15 is coming.

Note: The following applies to US citizens and resident aliens. If you made money from cryptocurrencies in foreign countries, you may also have to pay taxes there.

I bought some bitcoin (or other cryptocurrency). Do I need to report it on my taxes?

Not necessarily. It all depends on what you did after you acquired it. For now, the IRS appears to regard bitcoin and other cryptocurrencies like stock. So, if you bought bitcoin and held it all, no action is needed.

OK, I sold some bitcoin. Do I need to report it on my taxes?

Yes. Once you sell, and "realize" a gain or loss, you need to report it -- and pay taxes on any capital gains.

What are capital gains and losses?

In short, they're the difference between how much an asset cost when you bought it and when you sold it. If the price went up, it's a capital gain. If it went down, it's a capital loss. The IRS has published a longer and much more detailed explanation.

The other thing to know about capital gains is that the IRS categorizes them as short-term or long-term. Generally, the proceeds associated with assets you held for more than 365 days would be classified as long-term capital gains, which are typically taxed at 15 percent. Any assets held for a shorter time are short-term gains, and taxed like ordinary income -- at rates that can go as high as 37 percent. 

Of course, this works both ways. If you lost money on your crypto-shenanigans in 2017, you can deduct those losses on your return. (The IRS limits capital loss deductions at $3,000 per year.)

How do I calculate cryptocurrency capital gains and losses?

For each trade -- partial or complete -- you'll need to know the following details: 

  1. When you bought the coins
  2. How much you paid for them (in USD)
  3. When you sold the coins 
  4. How much you received for them

The more sophisticated exchanges may have a reporting mechanism to help you collect this kind of information. Otherwise, unless you've kept detailed records of your own, you may need to root through your email, bank or wallet receipts.  

Once you have that information in hand, there are several options available for doing the math. For example, some investors use the "first in, first out" (or FIFO) methodology, wherein the first coins you buy (and the price they cost) are also the first coins you sell. We won't cover all of the methods and maths here. You can use Google to learn more about the options for calculating capital gains.

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Which tax form do I use to report cryptocurrencies?

It all goes down on Schedule D, the federal tax form used to report capital gains.

I paid people using bitcoin. Do I need to file?

Yes, you'll need to report employee earnings to the IRS on a W-2. And if you compensated contractors with crypto, you'll need to issue them a 1099.  

I sold $100 worth of bitcoin last year. Do I need to worry about all of this?

Yes. Though the IRS typically dedicates its investigative resources to audit bigger fishes, you're better off playing it safe than sorry.

Will I receive any tax forms for the crypto exchange or marketplace I use?

This year, some exchanges may send a Form 1099-K to larger customers or commercial users who meet certain thresholds of volume or value. For example, Coinbase customers who completed more than 200 transactions or sold more than $20,000 in 2017 can expect to receive a 1099.

The $20,000 threshold is a significant one. In November 2017, a US district court ordered Coinbase to provide identification and transaction records for all US users who conducted at least one bitcoin transaction of $20,000 or more between 2012 and 2015. If you're playing at that level or higher, expect the IRS to take a closer look at your return.

I'm a bitcoin miner. Do I need to report the proceeds on my taxes?

Yes. Proceeds from mining bitcoin or any other virtual currency must be reported as gross income. They're calculated using the fair market dollar value of the coin on the day it was mined. 

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Does the new tax law impact cryptocurrency?

It sure does. Before, many "like-kind" exchanges -- trading a real estate asset for another real estate asset, for example -- were classified as tax exempt. Given the IRS's view that cryptocurrency is property rather than currency, many investors interpreted inter-crypto exchanges -- say, a trade of Bitcoin for ether -- as a non-taxable transaction. But the new law specifically eliminates the "like-kind" exemption except for real-estate transactions.

Can I use TurboTax or another app to help me sort this out?

Yes. TurboTax, H&R Block and some other online tax platforms will lead you through the filing process for these kinds of transactions. If your platform of choice doesn't support crypto, you should be able to use whatever system it has in place for reporting capital gains or losses related to stocks as a substitute. Note that there are also specialized tools available, like Bitcoin.tax, that can offer more specialized support for some of the more niche cases like mining. (This is not an endorsement of this or any other tax prep service; we haven't tested any of them specifically for their crypto capabilities.)

Who can help me figure out my bitcoin taxes?

If you're looking for more hand holding, we urge you to consult a tax professional. The basic tax code is notoriously complex, and crypto activity can get awfully complicated quickly. When in doubt, hire a pro.

And, as with everything cryptocurrency-related: do your research, pay your taxes and caveat emptor.

Buying and selling bitcoin, explained: A quick and dirty introduction to trading.

Bitcoin, Ethereum or Litecoin: Which is best for you?