As the 10th anniversary of Bitcoin passes by, murky waters continue to cloud the crypto seascape. Skeptics, supporters and talking heads alike have tabled the same questions that arose when cryptocurrency cannonballed into the public discourse in 2009: How exactly does it work? How can we ensure its security? Which cryptocurrency might emerge as the dominant medium of exchange?
Chief among them: Just how exactly can we account for them at tax time?
Hardly every (or any) crypto concern has met its solution. But in certain cases, the benefits of time, research, trial and error have given curious investors a few guardrails to grip. And on the issue of taxes and cryptocurrency, we’ve done our best to reveal everything you need to know in this guide.
Why It Matters to Crypto Investors
In the eyes of the U.S. Government, Bitcoin is not, in the case of the average investor, money. Only money is money. Perhaps no one has said it better than the IRS themselves:
“Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency — i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance — but it does not have legal tender status in any jurisdiction.”
So why does that matter for you, the potentially average investor? This notion alone — that cryptocurrency should be treated as something other than legal tender (and in the case of the United States, treated as property) — leads to an unsurprising endpoint: Tax dodging.
Intentional or not, people who incur even nominal losses or gains on the crypto markets may submit to the temptation of avoiding taxes altogether to avoid already-involuted tax laws seeping into their newest investment vehicle.
But the stakes are grave. Recent reports have seen crypto investors face prison time and as much as $250,000 penalties for mistakes or (“mistakes”) on their tax filings.
Long and short? When you invest in cryptocurrency, it’s important to get your taxes right the first time around.
Where to Start
Whether it’s Bitcoin, Ethereum, Bitcoin Cash, Litecoin, Ripple, Monero, Zcash (…we could keep going…) or any other type of cryptocurrency, you should always start in the same place.
Someone or something knows taxes better than you do.
It’s 2019. So you better believe the best tax software available has already built modules for crypto investors. Hunt around for the one that fits your crypto habits best — it shouldn’t take long.
Better still, programs like BitcoinTaxes and CryptoTrader can help you all along the way, accounting for all your tax obligations with as little as a spreadsheet documenting your trades. Pair them with your trusted tax software and life gets much, much easier.
How Your Cryptocurrency is Actually Taxed
While it’s nice to have the 1s and 0s on your side at tax time, nothing can supplant a real working knowledge of how crypto taxation works. The most important thing to know is that reporting is up to you. Freelancers, investors and those with retirement accounts are likely accustomed to banks, companies and financial custodians mailing the appropriate forms at the appropriate time. Not so much with crypto.
Most crypto exchanges will issue a reminder or an official statement if you’ve exceeded a certain amount in gains on the year — somewhere in the neighborhood of $20,000. Set an alarm or notch it on your calendar, because barring gains like that, you won’t get another reminder.
A couple more baseline items:
Anytime you sell cryptocurrency, you’ll be taxed.
That means it’s taxable income if you converted crypto assets into non-crypto assets, such as cash, goods and services.
Anytime you used cryptocurrency to buy something, you’ll be taxed.
Some cryptocurrencies have had to outgrow their reputation as the underworld’s medium of exchange, and to do so, federal agencies have gotten serious about accounting for every transaction that takes place, digital or not. Does it fly against crypto’s creed to become a truly anonymous ledger? It’s up for debate. But we’re light years away from a world of loosely governed, unregulated exchanged — until then, we all play by the same rules.
Some Other Factors You’ll Have to Consider
- Take stock of the type of cryptocurrency you own. While almost every cryptocurrency is taxed in the same fashion, there is a scenario where variety matters: Selling one cryptocurrency for another results in a taxable event. Be sure to consult an accountant before you attempt to offset your losses via washsale or any other technique.
- Keep tabs on the fair market value of the virtual currency measured in U.S. dollars, as of the date it was received. For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars.
- Know how you got it. Remember earlier when we mentioned that cryptocurrency is treated like property under U.S. tax law? That means their purchase and sale gets the same treatment as any other capital loss or gain. So, in turn, know how you used it, too.
- Know how long you’ve owned it. Tax rates depend on how long you’ve held on to a property — in this case, your crypto. If you hold onto your cryptocurrency for under a year, you’ll be taxed at short-term rates. If you’ve held it over a year, you’ll be taxed at long-term rates. Long-term rates are typically more favorable than short-term rates, so that might be something to bear in mind as you evaluate your trading strategy. The IRS has a comprehensive resource for navigating the relevant responsibilities to Uncle Sam.
What About Mining?
Most cryptocurrencies, Bitcoin being the most visible, allow users to “mine” that currency and in essence bring new monetary units into existence. Mining is a computing-intensive task that wards away most casual speculators and investors, but for those with the time, interest and horsepower to do it, it can be a valuable endeavor.
In the case of Bitcoin, the IRS assess mining income as business income like any other. As long as you’ve produced the equivalent of $400 USD or more in a calendar year, you’ll need to report it. If you own all of your own mining hardware, software and equipment, then a Schedule C is in order. Schedule C accounts for an ordinary income tax, plus a 15.3% self-employment taxes.
According to Coindesk, you may stand to benefit if your mining operation has already incorporated as a business and your net income exceeds $60,000. Business tax rules could be a little more generous, eliminating (or at least reducing) that additional 15.3%.
What About Cryptocurrency as Income?
There’s an added element for employers who pay out in cryptocurrency — each and every transaction must be converted to its USD equivalent at the time of transaction, then reported to the IRS on a standard W-2. Employees (and the self-employed) must do the same, reporting their W-2 wages in dollars at their worth on the day they were received.
Can You Pay Taxes in Crypto?
Yes, you can. For the investors and evangelists so devoted that American dollars are a thing of their past, there are states which allow crypto payments for crypto taxation. Ohio staked its claim as the first to accept cryptocurrency as tax payment.
Efforts to incorporate cryptocurrency payments in other states haven’t been quite as successful, but it never hurts to check with your state’s department of taxation.
Keeping Track of Your Transactions
All of that adds up to one thing: keep a log of your transactions. However you want to do it. By hand, by spreadsheet or by software, a log of your transactions is an indispensable tool during tax season. Whether you’re an employer, employee or investor, the last thing you want to do is going rooting through your past transactions, sifting through dates, times, gains and losses when you could have had them at your fingertips all along. Think simple — it doesn’t have to be a complicated template. Something like this:
Of course, that’s a crude interpretation of what the tax services might recommend. Take this as another reminder to set yourself up with the proper accounting software before you start buying, selling or mining. That’s another place you won’t want to play catch-up.
Many charities accept crypto payments. After all, why shouldn’t they? It’s another avenue for getting resources to the people who need it most.
As Forbes points out, charitable contributions of any form are treated kindly by the IRS. They come without capital gains tax, and allow donors to deduct the fair market value from the donated sum. Moreover, most charities are tax exempt. So should they choose to turn around and sell your donation on behalf of their cause, they won’t be taxed for it.
The Bottom Line
Cryptocurrency taxation is complicated, but far from impossible. In most cases, it serves an investor well to mentally frame it as property. In Bulletin 2014-21, the IRS states it as plainly as can be:
“For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.”
Beyond that, it’s on you to have the right people and programs in your corner. Do yourself a favor and find an accountant who has experience in the territory, and don’t hesitate to spend a few extra dollars on software that’ll help you organize your transactions on the fly.
If trading cryptocurrency is worth the risks, then surely a little safeguarding at tax time is worth the reward.