Bitcoin is a cryptocurrency. A type of electronic cash. It is decentralized digital currency without a central bank or single administrator that can be transferred from one individual user to another on the peer-to-peer Bitcoin network without any requirements for intermediaries.
Bitcoin had its coming-out party in 2017. With all the excitement and opportunities around cryptocurrency, it might be easy to forget about crypto taxation. Almost all bitcoin or other "altcoin" transaction such as mining, trading, spending, exchanging, air drops, etc. will likely be a taxable situation for U.S. tax purposes.
Every bitcoin transaction either bought, sold, or traded comes with tax consequences. Bitcoin and other convertible virtual currencies are considered property and not treated as currency according to the Internal Revenue Service.
It might be viewed as a minor distinction, but not so. It is a factor that determines how bitcoins are taxed, the required information to ensure your taxes are correctly calculated, and the tax planning techniques available to reduce your taxes on bitcoin transactions.
A capital gain or a capital loss can be gotten when you dispose of bitcoin because virtual currencies are regarded as property for tax reasons. A profit is considered an income, and income is taxable even if payment is made in virtual currency.
Spending virtual currency is a different matter. You'd possess double transactions in one: You are successfully disposing of the virtual currency and spending its equal dollar amount.
The IRS considers Virtual currency as a digital representation of value that serves as a means of exchange or a unit of account. It does not possess the status of legal tender in any jurisdiction. Any virtual currency that has an equivalent value in real money, or that serves as a replacement for real currency is denoted as 'convertible' virtual currency.
Bitcoin can be traded digitally between different users and can be bought for, or converted to U.S. dollars, and other currencies, hence it is considered as an example of a convertible digital currency
The IRS also says that For federal tax purposes, virtual currency is calculated as property. Therefore general tax principles that used for property transactions apply also to transactions involving the use of virtual currency. A taxpayer who gets virtual currency as payment for goods or services must, in gross computing income, includes the fair market value of the virtual currency, calculated in U.S. dollars, depending on the received date of the virtual transaction.
Transactions carried out with virtual currency must be reported in U.S. dollars. Taxpayers are required to estimate the fair market value of the virtual currency in U.S. dollars as of the date the transaction was carried out. If a virtual currency is on an exchange, the fair market value of the virtual currency is determined by changing the virtual currency into U.S. dollars at the exchange rate, in a sensible manner that is consistently applied.
Every bitcoin transaction can be taxed. Bitcoin users will be required to calculate their gain or loss each time goods and services are bought with bitcoin.
The IRS considers bitcoin and related convertible virtual currencies are property for tax purposes. Same with other types of property, the property is first acquired by exchanging cash for the property, then the property becomes yours for some time. Eventually, you might decide to sell, trade, give away or otherwise dispose of the property.
There are three (3) essential moments in time that are vital to the taxation of all types of property, including convertible virtual currencies. It involves when you purchase it, the length of time you hold it, and when you sell it off. The property is taxed when you sell.
When Bitcoin Is Sold
Four essential things happened when the property sold off:
a. Income is gotten from any profit made.
b. Gain is calculated by the change in the dollar value between the price at which it is purchased and the gross proceeds received from the disposition (the selling price).
c. The tax rates that apply vary whether the property was held for a short or long period.
d. Distribution of property is reported on your tax return using Schedule D and Form 8949 or Form 4797. These forms require that you show evidence of calculation of loss and gain. Assuming you buy bitcoin for $20,000. And sell for $50,000, so you made a profit of $30,000. If the bitcoin was held for a year or less, this is considered a short-term gain, so it is taxed as ordinary income based on your tax bracket. If the bitcoin is held beyond a year, it is seen as a long-term gain that taxed at either 0% 15% or 20% rate based on your overall income.
Advanced Accounting & Tax Planning