Heads up, Bitcoin buyers–tax season is coming soon and your investment will likely have an impact. Are you a bit confused about how it works? We’ll explain it all in our easy-to-follow Bitcoin tax guide.
Unless you’ve known about Bitcoin since its inception, it may seem a little mysterious to you–even if you own some. And that can make things like thinking about Bitcoin and your taxes a bit daunting.
Typically when we think of taxes, we are thinking about dollars and cents. But with Bitcoin, it all seems so different. But here’s the deal: it’s really not.
Investing in Bitcoin is just like investing in any other capital asset, like a home. Because Bitcoin is currency, it’s considered property. According to IRS guidance, virtual currency acts as “a medium of exchange, a unit of account, and/or a store of value.” The IRS goes on to say that virtual currency can be used at a medium of exchange to buy and sell goods, but it doesn’t have legal tender status in the U.S.
Virtual currency, again, is treated like property for tax purposes. So principles that apply to property transactions, like buying or selling a home, also apply to buying, selling, and using virtual currency like Bitcoin and other cryptocurrencies.
So what does that actually mean as far as your taxes go? Here are some things you need to know:
Bitcoin Tax Guide – Basic Terminology
The terminology that applies to virtual currency transactions also applies to other transactions. If you’ve ever sold a home and had to pay taxes because of that, you’ve heard some of these terms.
The first is capital asset. This is anything you own, including stocks, bonds, your home, and your cryptocurrency. The basis is the amount you paid to purchase the property, including any fees that you paid.
Capital gains and losses are the profit or loss you can make on the property. These gains or losses are unrealized when they’re still just on paper. When you actually sell the property, though, the capital gains or losses become realized, and that’s when they have tax implications.
Short-term gains are realized gains on any investment that you held less than a year before selling. Long-term gains are realized gains on assets you’ve held for more than one year before selling. These are important because they’re taxed differently.
Is all of this as clear as mud? Here’s a quick tutorial to illustrate the terms:
Let’s say you buy one bitcoin for $10 (yes, I know, that’s now impossible). You pay a $1 fee during the purchasing process. Your basis is $11. In a year, the bitcoin is worth $100. You hang on to it longer, you have an unrealized capital gain of $89. After another year, it’s worth $189, and you sell the bitcoin. You now have a realized long-term capital gain, which is now taxable.
Get Your Information Together
When it comes to filing taxes for anything, it’s really all about having the right information available when it’s time to file. For bitcoin and other cryptocurrency, the information you need includes:
- The basis (cost plus fees) of any Bitcoin you buy
- The purchase date
- If sold, the date you sold it
- The price you sold it for
As you can see, keeping good records of cryptocurrency transactions is essential. This is one reason many people use the same cryptocurrency exchange option, so that the records are easy to dig up.
Using this information, you can figure out how much tax you’ll pay on your bitcoin. This is also a helpful exercise to walk through if you’re just considering selling some bitcoin. You’ll want to know what taxes will look like before you make the decision to sell.
One Major Difference to Note
One weird quirk about bitcoin is that you technically sell it even if you’re using it to purchase something directly. When you sell your bitcoin, the IRS considers that selling the bitcoin for cash and then using the cash. So you’ll need to pay taxes on the bitcoin you sold, even if you technically used it to purchase something.
And, yes, this is true even if you’re shopping somewhere like Overstock.com, which directly accepts Bitcoin as a method of payment. Because cryptocurrency isn’t considered legal tender in the U.S., all bitcoin transactions trigger potentially taxable events.
For this reason, you want to keep track of more than just bought and sold dates if you’re using cryptocurrency for everyday transactions. You’ll also need to keep track of when you use the bitcoin and what its value is when you happen to use it.
Something similar can happen if you use physical property during a transaction. But it’s less common to do this with other types of property versus cryptocurrency. So be sure you keep incredibly detailed notes about when you buy, sell, or just use cryptocurrencies like Bitcoin.
How Much Tax Will You Pay?
So if you’ve triggered taxable events with your bitcoin this tax year, your taxes will depend on the circumstances and your personal tax bracket. Here’s how it works:
Taxes on Long-Term Capital Gains
This is the best case scenario. Long-term capital gains are taxed at a lower rate than your actual income tax, but the rate depends on your tax bracket. The 2017 Tax Cuts and Jobs Act goes into effect for 2018 taxes. The act changes the way capital gains taxes are assessed slightly.
Long-term capital gains taxes used to work based on your tax bracket. That’s no longer the case. Now, you’ll pay either 0%, 15%, or 20% on long-term capital gains, depending on your maximum taxable income level. For instance, single taxpayers making up to $38,600 will pay no long-term capital gains taxes. Single taxpayers making between $38,600 and $425,800 will pay 15%, and single taxpayers making over $425,800 will pay 20%.
In short, the majority of taxpayers will pay 15% on long-term capital gains. But you may pay more or less depending on your income.
So if you do a pure buy-hold-sell transaction on Bitcoin, it’ll work like this. Say you buy a Bitcoin for $1,000 on January 1, 2016. You sell it for $2,000 on January 1, 2018. Your capital gain would be $1,000, and you’d pay either $0, $150, or $200 in taxes on the sale come tax season.
Taxes on Short-Term Capital Gains
What if you buy a Bitcoin and only hold it for six months, or even 364 days? If you sell it for a gain, that’ll be taxes as a short-term capital gain. Short-term capital gains are considered regular income, so they’re taxed at your regular income tax rate. So if you’re in the 24% tax bracket, you’d pay $24 on a $1,000 short-term capital gain.
What About Losses?
The way the cryptocurrency market is going these days, you shouldn’t be looking at any losses. But if you do lose money in a cryptocurrency transaction, you’ll deduct the loss on your return. It’s possible to deduct capital losses even if you just take the standard deduction. The deduction’s amount will depend on your tax bracket. But you can only claim up to $3,000 per year in capital loss deductions, so keep that in mind when you’re considering selling Bitcoin at a loss.
What About Transactions?
All of this can seem more confusing when it comes to using Bitcoin or other cryptocurrency to actually make a purchase. But it’s actually fairly straightforward. Let’s say you buy a coin for $1,000. Then you use it to purchase $2,000 worth of kitchen remodeling goods on Overstock.com. That transaction will trigger a capital gains tax on $1,000 worth of capital gains.
Why? Because it’s as if you sold the coin for $2,000 and then turned around and bought something with the resulting cash. Again, this is the case even if Overstock accepts cryptocurrency directly.
It’s similar to cashing out a stock and then using the resulting money to purchase something. The IRS doesn’t really care what you do with the money you get. They just want you to pay taxes on the gain.
A Couple More Scenarios
Cryptocurrency offers a couple of other interesting scenarios to consider from a tax perspective. One is mining coins. When you mine a new coin, it’s considered income according to the fair market value of the coin on the day you mined it. So you’ll count this as another type of income on your taxes.
When you receive payments in cryptocurrency, that also counts as income according to the fair market value of the currency on the day you get paid. And when you exchange one coin for another, it triggers taxable events just like using cryptocurrency to buy goods. It’s like you sold the currency for cash and then used the cash to purchase more currency.
Why Should I Care?
Some people are migrating towards Bitcoin and other cryptocurrencies because they’re interesting and maybe a good investment. Others are migrating this way because they believe less government oversight is a good thing. Regardless of why you’re using or investing in Bitcoin, you should care about the tax implications.
The IRS is paying close attention to cryptocurrency users now, after the vast majority haven’t paid taxes on their crypto transactions. Failure to pay your taxes involves potentially steep penalties and fees–not to mention endless letters from the IRS. So be sure you understand how to pay taxes on your Bitcoin, when you should do so, and how much tax you should pay.
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