Understanding Bitcoin taxes and your obligations for reporting gains and losses can be a bit daunting. The important thing to realize is that the IRS takes cryptocurrency taxation seriously, and it is wise that you do so too. Reputable exchanges, like Coinbase, issue 1099-Ks to higher-transacting customers and will provide the IRS with your taxpayer ID and historical transaction records.
For the sake of simplicity, this post is written about U.S. tax obligations, so be sure to check the specific tax requirements for your country. Unlike bitcoin, we tend to think in terms of dollars and cents when it comes to taxes, but it really makes little difference to the IRS. Your Bitcoin investments are the same as any other capital asset, since virtual currency is considered to be property.
The same principles apply to bitcoin as when buying or selling a home. A capital asset is anything you own, such as your home, cryptocurrency, stocks, bonds, etc. The basis is exactly the amount you paid to purchase said property, including any fees. Capital gains and losses are the profit or loss incurred for said property and remain “unrealized” until you actually sell the property. Once you sell your crypto, the gains or losses become “realized” and there are tax implications.
Trading Gains & Losses
Since the IRS has determined that bitcoin is considered property, not currency, accrued long-term gains and losses will be taxed at each investor’s applicable capital gains rate. Long-term means the property or crypto has been owned for one year or longer before being converted to fiat. This is good news as opposed to gains and losses being taxed at ordinary income rates, which is the case with short-term gains and losses.
The IRS caps net capital losses at $3,000 per year for married and single filers on personal tax returns. This limit has been effective for nearly 40 years, and it means that large short-term trading losses may have to be carried forward for years. If you have suffered trading losses it is important to understand the write off is not the same as with “foreign currency” losses against ordinary income.
Fair Market Value
The next issue to tackle is the cost base. The IRS requires the reporting of the fair market value of bitcoin holdings for the date that the currency was received. One may determine this fair market value using a daily high or low value from exchanges, but it is important to be consistent. In other words, if you use a daily high from one exchange, don’t use a daily low from a different exchange to artificially reduce your tax liability. Of course, there is currently no way reporting can be 100% consistent across these lines.
Bitcoin taxes start to get complicated when it comes to cost bases. Traders have the right to calculate their cost bases using one of several different methodologies.
- FIFO – First-In-First-Out
- LIFO – Last-In-Last-Out
- Specific Share Identification (commonly used in stock trading)
Depending on which method is used, a major impact on the calculations of both long- and short-term capital gains could be the result. For example, if you bought coins more than a year ago and used the buying price as the cost base, you would benefit from a lower long-term capital gains rate. You could also sell the shortest-held bitcoins and realize a lower nominal gain but be taxed at a higher capital gain rate. Some exchanges automatically incorporate FIFO or LIFO for investors, with no regard to which may be the most tax-friendly method.
As an investor, you may prefer to sell off bitcoins purchased at a different time as a means of writing off ordinary income. Then you might sell a different lot in order to realize a smaller long-term capital gain. These legal personal accounting methods could result in significant tax savings. However, this level of sub-accounting is not implemented on major exchanges, and not likely to be in the near future.
eCommerce Bitcoin Taxes
To complicate the matter of bitcoin taxes further, suppose you buy a cup of coffee from a vendor accepting bitcoin. Doing so would constitute a gain or a loss, and if you are a long-time investor having seen bitcoin value rise, there would be a significant capital gain tax. The IRS has deemed there is currently no exemption for “de minimis” property gains or losses as there are when using foreign currencies. The IRS requires that the bitcoin investor keep track of each incremental capital gain, and report them via a Form 1099-B come tax time. Only time will tell whether Congress will step in and approve a bill exempting such small transactions.
Donations, Tips, and Gifts
Making donations to charities in bitcoin can present a significant tax liability and a professional tax advisor should be consulted to ensure the best outcome. There is a difference regarding tax liability depending on how the donation is presented to the charity. If one were to sell the bitcoin being donated, either a 15% or 25% tax liability would be realized. The donation is considered tax-exempt and can be used to offset the liability. It could be more tax-favorable for the donor to give the charity bitcoins directly, which had been held longer than a year. The IRS allows donors to write off the entire fair market value of the donated property held for over a year (up to 30% of adjusted gross income) without stipulating a capital-gains tax.
The recipient of a gift is usually exempt from taxes for that gift, although that may not always apply when it comes to digital currencies. The issue is that gifts of property which realize a capital gain or loss upon sale are taxable, so keeping track of all the cost bases for different donations can get complicated. Whenever a gift is converted into cash or used to buy something, it is a taxable event.
Bitcoin Taxes on Lost, Stolen or Hacked Coins
What about lost, stolen or hacked bitcoins? Such losses are governed by Section 165 of the tax code. Individual losses are subject to a $100 floor and are deductible, but only to the extent that the taxpayer has a total loss for that year in excess of 10% of adjusted gross income. An investor that loses $20,000 worth of bitcoin but realized $10,000 in capital gains, would be entitled to claim a loss for the tax year in which the loss occurs and pay $1,500 in capital-gains taxes. Should your private keys be lost, stolen, deleted, destroyed, or damaged – you will not be able to write off the losses.
Whether you’re interested in cryptocurrencies as an investor or trader, it pays to learn about the tax implications and make wise decisions. Since the vast majority of bitcoin users have not paid taxes on their transactions, you can bet the IRS is paying close attention. No gains are worth the interest, penalties, and stress of having the IRS on your case.