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 .
- 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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