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Posted by Jim McClaflin, EA, NTPI Fellow, CTRC

Your Bitcoin & Other Crypto Assets are Taxable: How to Report Virtual Currency to the IRS

Your Bitcoin & Other Crypto Assets are Taxable: How to Report Virtual Currency to the IRS

Taxes are one of the only certainties in life, and cryptocurrencies are no exception.

Yes, your Bitcoin is taxable. The IRS treats ownership of cryptocurrencies as "property" for tax purposes, which means that your virtual currency is taxed the same way as any other asset you own, such as stocks or gold.

For most people who buy and trade cryptocurrencies online, accounting for them on your tax return is relatively easy. But, like most things about digital currency, things can get a lot more complicated the more active you are.

Here's what you need to know about the business that you may need to report to the IRS and how you can start planning your taxes ahead of time.

Reporting cryptocurrency trades on your tax return

Purchasing cryptocurrencies with dollars

Simply buying a virtual currency in U.S. dollars and keeping it within the exchange you purchased from or transferring it to your personal wallet does not mean that you have to pay taxes at the end of the year.

If your only cryptocurrency activity this year was purchasing a virtual currency in U.S. dollars, you do not need to report it to the IRS, per the instructions in the 1040 tax return form.

Cryptocurrency Trading

Things start to get taxable when you use cryptocurrencies as a method of exchange. This includes selling your cryptocurrencies for U.S. dollars, exchanging one cryptocurrency for another (buying Swipe with Bitcoin, for example), or paying goods and services with crypto.

Every time you sell the investment or switch the investment for another investment, there is a taxable transaction. You have to be careful if you do a lot of transactions. If you enter and exit different types of cryptocurrency trades, it will be considered a taxable event.

When you have to pay taxes on cryptocurrencies

Since the IRS considers virtual currency properties, their assessed value is based on capital gains or losses - that is, the amount your assets have gained or lost during a given time. 

When you trade cryptocurrencies or spend cryptocurrency buying something, these transactions are subject to capital gains tax because you are spending capital on getting assets.

The difference between the amount you spent when you bought or received the crypto (your cost basis) and the amount you earn from the sale is the capital gain or loss, which you will report on your tax return. In general, if you bought Bitcoin worth $10 and sold it for $50, you will end up with a gain of $40. If your Bitcoin loses value during this time, you will experience a loss of capital. If your losses exceed your gains, you can deduct up to $3,000 from taxable income (for individual taxpayers).

The amount of time you own the cryptocurrency plays a role. If you have owned a Bitcoin unit for more than a year, this will generally be seen as a long-term gain. But if you buy and sell within a year, that's a short-term gain. These differences may affect the tax rate applied. The tax rate also varies based on your overall taxable income, and there are limits to how much you can deduct from losses if your cryptocurrency asset goes down in value.

You can use Form 8949 to reconcile your capital gains and losses and then report them on your Form 1040 tax return using Schedule D. The IRS website has additional information and tools to help you determine your capital gains tax payable and how to report it on its website. However, to avoid making mistakes, it is advisable to get the services of a tax expert. 

Reporting Crypto Income

Some people receive virtual currency as payment for services. This could mean receiving cryptocurrencies as income instead of cash, earning Bitcoins by mining new coins or receiving coins or tokens as a reward for certain activities (Coinbase, Blockchain earn rewards, for example). Regardless of how it is obtained, you will need to record the value of the cryptocurrencies in U.S. dollars upon receipt and report the income on your tax return.

The IRS states: "A taxpayer who receives virtual currency as payment for goods or services must, in calculating gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date to which the virtual currency was received. "

The fair market value you buy is tied to that currency as a cost basis, which it is your responsibility to monitor. So if you buy something with the crypto you earned, you will need to reconcile the base price with its value when using it for goods or services.

Track your activity

One of the most important things to keep in mind when starting to trade cryptocurrency is that it is your responsibility to keep track of all of your potentially taxable activities and the fair market value of the cryptocurrency in all these activities.

The Internal Revenue Service (IRS) provides only general guidance on what documents you will need to keep for tax purposes: they should be sufficient to "establish the positions taken in tax returns." Some examples provided by the agency include records each time you receive, sell, or trade virtual currencies, as well as the fair market value of your virtual currency.

Some exchanges may issue a Form 1099-B to help you determine profit and loss, but this is rare. Finally, you are responsible for tracking your taxable assets and the fair market value of your currency.

If you leave your virtual currency in your account at the exchange where you bought it, it's often easy to track or report your transactions. But if you move your currency between private wallets or have encryption in multiple places, you will need to be more careful with its tracking.

How to Prepare for Tax Season When You Have Bitcoin

The best thing you can do to simplify your 2021 cryptocurrency tax return is to start planning ahead. Don't wait until the due date to start collecting reports and figuring out what you owe, even if that's the normal way to approach tax season.

You don't want to find yourself in the situation when you're trying to recover crypto activity for a year. You really want to treat it more like a business where you make sure all of your taxes are updated monthly, make sure you keep track of things, be more proactive about it.

Suppose you are just starting to trade Bitcoin or other cryptocurrencies and only have a few transactions (with accurate cost-basis reporting). In that case, you can easily report your cryptocurrency income using your typical tax software.

Consider working with a professional.

Even if you don't do complex crypto business and only have questions about your specific tax obligations or aren't sure you're filing properly, consider working with a tax professional with experience in interpreting the virtual currency tax code.

The IRS and other regulators cannot provide advice on every situation in which a taxpayer may be found, and there are many loopholes in current guidance. This is why it is important to seek a tax professional who is familiar with current IRS guidelines and who is experienced in reporting cryptocurrency gains and losses.



Jim McClaflin, EA, NTPI Fellow, CTRC
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