Cryptocurrency: A Guide to Common Tax Situations

Many retail investors entered the world of cryptocurrency investing in 2017, buying coins such as Bitcoin, Ethereum, Litecoin, or any other virtual currencies. With the 2017 tax filing season now upon us, those investors need to figure out how to report their cryptocurrencies on their tax return.

The IRS issued a key piece of guidance back in 2014. For tax purposes, bitcoin and other cryptocurrencies are treated as property. That means cryptocurrency transactions are handled just the same way as buying and selling stocks, bonds, real estate and other types of property. When you purchase cryptocurrency, you establish your cost basis in the coin. Later, when you sell or trade the coin, you will recognize capital gain income.

But unlike other types of investments, you are not going to receive a Form 1099 summarizing your taxable income. That means you will need to gather and keep track of the relevant information needed to prepare your tax return accurately.

This article explains what the typical cryptocurrency investor will need to know before filing their 2017 tax return. Given the additional complexities and unique transaction types associated with cryptocurrencies such as forks and airdrops, we highly recommend consulting a Visor tax advisor this year.

What cryptocurrency transactions need to be reported on my tax return?

You will need to report on your tax return any disposition of cryptocurrency.

The typical way people dispose of bitcoin or ethereum is to sell their coin for cash. This is a straight-forward capital gain transaction. You record as capital gain income the difference between your purchase price and the selling price of the cryptocurrency.

But dispositions also include converting one cryptocurrency into another, and trading cryptocurrency for goods or services.

So if I sold Bitcoin to buy Ethereum, it would be a taxable event?

Yes. Exchanging one cryptocurrency for another cryptocurrency has two parts: disposing of the first cryptocurrency and acquiring the second cryptocurrency.

For example, if you bought one bitcoin at $400, and then later traded that one bitcoin for one ethereum when the value of both coins was at $1,000, then this transaction is recorded as a $600 capital gain on the bitcoin. The person would have $1,000 cost basis in the Ethereum coin.

This answer often comes as a surprise. But if we go back to the IRS’s guidance, we can see how this makes sense. The IRS views each cryptocurrency as property. Think about what happens if you sell Apple stock and buy shares of Google. You would report the sale of the Apple stock as a taxable event. For tax purposes, it does not matter that your sale proceeds were reinvested into a new investment.

If I bought a good or service, such as web hosting or pizza, with Bitcoin, would that be a taxable event?

Yes. Just like using cryptocurrency to buy a different cryptocurrency is a taxable event, so is using bitcoin or other cryptocurrencies to buy goods and services.

For example, you bought web hosting services worth $250, and paid for the service with one-fourth of one bitcoin when each bitcoin was worth $1,000. This transaction would be recorded as a capital gain transaction showing that you sold one-fourth of a bitcoin.

I received Bitcoin Cash after the “hard fork” on August 1, 2017. Does that impact my taxes?

Yes. The dollar value of Bitcoin Cash that you received during the hard fork is additional income for tax purposes.

The challenge is figuring out how to calculate that value. And here’s where a tax advisor comes in handy. We will need to take into consideration when a taxpayer had access to their Bitcoin Cash coins, and determine which exchange and which exchange rate to utilize to calculate the conversion into dollars. The important thing is that taxpayers should add a footnote to their tax return to show the IRS how they determined the value of their Bitcoin Cash. That way, the taxpayer is upfront with the IRS about how they did the math, and this can avoid penalties if the IRS subsequently challenges the calculation method

What else should I know about tracking cost basis?

Cost basis is the purchase price in U.S. dollars for your various cryptocurrencies. This information is needed to measure the capital gain or loss when the cryptocurrency is sold or otherwise disposed of. Cost basis also includes transaction fees for buying, selling, transferring or exchanging cryptocurrencies.

Example: you bought 100 coins for $1,000 in May 2016. Your wallet provider charged a fee of $15 to purchase the coins. Your cost basis is $1,015 for 100 coins, or $10.15 per coin.

For tax reporting, you will need to maintain a record of your cryptocurrency transactions. Some wallet services provide their customers with a spreadsheet detailing buys and sells, which is a great place to get started .

Key takeaways:

  • Basis tracking will be the biggest complication for most cryptocurrency investors. Unlike when trading stocks, you will not receive a Form 1099 summarizing your trading profits for the year. This IRS expects you to track buys and sells.
  • Anyone owning Bitcoins as of August 2017 received an equal amount of coins of Bitcoin Cash after the “hard fork.” You will need to make a determination along with your tax advisor as to how you wanted this reported on your tax return.

 

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17 Comments

    1. Day trading in cryptocurrencies is handled exactly the same way as other types of trading. Each sale or other disposition of cryptocurrency is reported on Form 8949. This is the form used to detail each sale transaction of stocks, bonds, and other investment property. The only difference is that a day trader is likely to have more transactions, and so the Form 8949 will be longer. Ideally, we try to get the cryptocurrency transactions organized in a spreadsheet. That way we can import all the transactions into our tax software. Any loss from cryptocurrency first offsets positive income from other capital gain transactions. If there’s a net loss for the year across all capital gain transactions, then up to $3,000 of that loss offsets your other income, and the remainder carries forward to next year. Hope this helps! We would love to work with you. Cheers!

  1. My son was day trading his account and received a significant 1099 from Coinbase. He was day-trading for a period of time trying to make $1,000 here and there. In the end, he made about $39,000 before expenses. I read somewhere that crypto currency has a maximum 15% tax rate. Is that true?

    1. Hi Michael, thanks for reading our tax blog! Your question is very interesting. To answer your question directly, the maximum tax rate on cryptocurrency is either 43.4% or 23.8%. But that information by itself is only part of the story.

      Here’s what we are looking at from a tax point-of-view. We need to separate out each trade, and measure the length of time each cryptocurrency was owned. If the currency was owned for one year or less, then the trade is categorized as a short-term transaction. If the currency was owned fore more than one year, then the trade is categorized as a long-term transaction.

      Next we add up the gains or losses from all short-term transactions. The net amount of income from these short-term trades are taxed at whatever ordinary tax bracket the investor happens to fall into. This ordinary tax rates range from 10% on the low end to 39.6% on the high end. Plus some higher-income people pay a surtax of 3.8% on their investment income. That brings the highest possible tax rate on short-term transactions to 43.4%.

      Next we add up the gains or losses from all long-term transactions. The net amount of income from these long-term trades is taxed at the long-term capital gains tax rates. These rates range from a low of zero percent, to a middle rate of 15%, and finally the highest rate is 20%. Again, some higher-income people a surtax of 3.8% on their investment income. That brings the highest possible tax rate on long-term transactions to 23.8%.

      I hope this sheds more light on the situation.

      We would love to work with your son as a client. So please let him know!

    1. Hello, Holly G. Yes, if you mine for cryptocurrency, any coin or rewards you receive from mining is taxable income. You can also deduct expenses related to this mining activity — such as the cost of hardware and utilities and other expenses that are directly related to the production of this income. From a tax perspective, we typically consider mining as a self-employed activity. Our of our tax accountants is a crypto miner, so we are familiar with how this works and how to report in on a tax return. We would love to work with you as a client. All the best, William.

  2. What about mining bitcoins or other cryptocurrency and just sitting on them? How does the IRS view this?
    Also, to touch on a previously answered question, when trading bitcoins for goods, it is considered a taxable event you said. Example: I buy $3000 USD worth of bitcoin cash on coinbase (assume a trasnaction fee of 1.49% from coinbase leaving me $2955.30 equivalent), and immediately “spend” that entire amount of bitcoin cash on mining hardware. I will have realized a net loss of 1.49%. How would IRS expect me to report this and what would the tax obligation be?

    1. Richard, Excellent questions!

      Mining rewards are treated as ordinary income. The amount of income claim is based on the fair market value (FMV) at the time of receipt. FYI: Mining rewards could be subject to self-employment tax, depending on your tax situation. When you claimed the ordinary income, you have established the basis in your mined coin. When you sell the mined coin, you will reduce your proceeds by the basis (proceeds – basis) to calculate your gain.

      Example:
      In year 1 let’s say you have mined one BTC, the value of BTC at the time is $10,000, you have zero expenses, and you did not sell the coin this year. You will report $10,000 of ordinary income on your tax return. Now in year 2, you sell the BTC for $25,000. On year 2’s tax return, you would pick a capital gain of $15,000 ($25,000 – $10,000). Your capital gain rate will be determined by how long you held the BTC, your current income level, and other tax factors.

      Even if you do not sell your mined coins right away, you still must pay tax on the income your mining activity generated.

      If you purchased 1 BCH for $3,000, but you were charged a 1.49% fee that is deducted out of your purchase, you would have .985 BCH with a basis of $3,000. Then you buy mining hardware for a cost of .985 BCH or $2,955 (if one BCH = $3,000), you would have a capital loss of $45 ($2,955 – $3,000).

      1. To add to what Alex mentioned above, Richard would also depreciate the cost of his mining hardware. This depreciation would be claimed as a deduction against any mining rewards income for the year.

  3. I mined a few coins in 2013 and did not declare in in 2013 return (mostly because was not sure whats the process), and sold them in 2017. what is the impact. Can I show the sale with cost basis as 0 in 2017 return. or should I show the mined coin with cost basis on the date mined and refile my 2013 return with the mining income? do you guys handle these, if so can you give me a ball park estimate. thanks!

    1. Hi Caleb, our tax advisors will work with you to figure out how best to remedy this situation. We can give you a price quote once we have a better understanding of how much work it takes to prepare your return. We would love to prepare your tax return. You can sign up for our service, and from there schedule time to talk to a tax advisor.

    1. What an excellent question, Patrick. There’s really not much difference between transactions happening within one crypto account as compared to several accounts. The important thing is to identify any transactions where crypto was transferred from one account to the other. From an accounting perspective, this a nuts-and-bolts process of aggregating the transaction data from your several exchanges and then laying out the data so we can analyze it properly. To help facilitate this process, we recommend that our clients utilize a third party service to generate a report of your cryptocurrency gains. If you don’t already have a preferred provider, we suggest using Bitcoin.tax or CoinTracker.io.

    1. Alex, great question! You will need to report on your tax return any disposition of cryptocurrency. “Dispositions” means the sale (or implied sale) of any crypto. This includes sales of crypto for fiat currency, or trading one coin for another, or purchasing goods and services by paying for it with crypto.

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