Bitcoin Taxes In : A Guide To Tax Rules For Cryptocurrency
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With bitcoin, you can run afoul of the IRS in a few surprising ways, so it pays to learn the rules.
The big picture? Bitcoin and other cryptocurrencies that you buy, sell, mine or use to pay for things can be taxable. Also, if your employer or client pays you in bitcoin or other cryptocurrency, that money is taxable income. You report your transactions in U.S. dollars, which generally means converting the value of your cryptocurrency to dollars when you buy, sell, mine or use it.
Heres more on how using bitcoin can affect your taxes:
How The Irs Taxes Cryptocurrency And The Loophole That Can Lower Your Tax Bill
Although cryptocurrencies like Bitcoin can be used to make purchases of anything from hand-made crafts to, in the near future, a Tesla electric vehicle, if you convert that currency to cash rather than pay in the form of crypto, you could be liable for capital gains tax. Every time you convert Bitcoin to cash it is technically a taxable event, says Daniel Polotsky, CEO at CoinFlip, a Bitcoin ATM operator.
However, whether or not you earn money on the transaction determines whether you may have to pay capital gains tax or can declare a loss on your taxes, which could reduce your tax bill by offsetting other gains or up to $3,000 in your adjustable gross income. Most people only think about reporting transactions when they make money, Polotsky says. Reporting losses can help people save on their taxes, as well.
Capital Gains Vs Capital Losses
Heres some good news for crypto taxes: You only owe taxes if you spend or sell it and realize a profit. If you sell or spend your crypto at a loss, you dont owe any taxes on the transaction.
If you bought $10,000 in Bitcoin and sold it for $13,000, for example, your taxable gain would be $3,000. But if you sold the same Bitcoin for $7,000 youd owe nothing in taxesand could even use part of your $3,000 in Bitcoin losses to offset other investment gains.
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How Cryptocurrency Is Treated For Tax Purposes
Many people are quick to point out how cryptocurrency is not backed by any government and, thus, subject to less regulation than fiat currencies like the dollar or euro. This lack of oversight has led many to believe that cryptocurrency investors are participating in elusive and anonymous transactions that allowed them to avoid paying taxes. However, this belief is absolutely false. In the United States, crypto exchanges must report user activity on gains and losses to the Internal Revenue Service , and cryptocurrency is taxed in much the same way as traditional stocks or similar assets.
Cryptocurrency is considered “property” for federal income tax purposes, meaning the IRS treats it as a capital asset. This means the crypto taxes you pay are the same as the taxes you might owe when realizing a gain or loss on the sale or exchange of a capital asset.
For instance, when you purchase a capital asset be it a stock, bond, exchange-traded fund, house, Bitcoin, or any other investment you initiate a basis equal to your cost to acquire it. When it comes time to sell your capital asset, you simply compare your net sales proceeds to your original basis to determine whether you have a capital loss or a capital gain. If the proceeds exceed your original cost basis, you realize a capital gain. When reversed, you’ve locked in a capital loss.
Choosing An Accounting Method
When investors sell multiple assets with different bases, they can either choose to sell the crypto theyâve held the longest first , or sell the newest ones first . In theory, you can choose which method you would like to apply, however, many in the crypto-tax industry believe FIFO is the only appropriate treatment unless you can specifically identify which coin you are selling. Contact a tax professional if you don’t know how to calculate crypto taxes or for any other questions.
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How Is Crypto Interest Taxed
Currently, platforms like Gemini and BlockFi offer users interest rewards for holding select cryptocurrencies. Meanwhile, DeFi protocols like Compound offer users rewards for staking crypto.
Cryptocurrency interest and crypto staking rewards are both considered personal income and are taxed accordingly.
What Is At Risk If You Are Being Targeted In A Cryptocurrency Tax Audit Or Criminal Tax Fraud Investigation
If you invest in cryptocurrency and you are a U.S. citizen or resident living in Boston, you have obligations to the IRS. The IRS has clearly stated its position that, under the Internal Revenue Code, U.S. persons are subject to tax on worldwide income from all sources including transactions involving virtual currency. You could owe tax obligations to local, state and international taxing authorities as well.
The IRS Criminal Investigation Division has identified cryptocurrency tax fraud as an ongoing focus area, and in 2019 the IRS began sending warning letters to Bitcoin and other cryptocurrency investors. If you have received a warning letter from the IRS and even if you havent you need to be extremely careful to avoid substantial penalties and the potential for criminal prosecution.
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What Is A Crypto Tax Calculator
Cryptocurrency represents a great opportunity to diversify your investment portfolio, maximize your profits, andâ¦ save on your taxes. Yes, you read it right: you must pay taxes on cryptocurrency. And yes, the IRS has the means to control that.
Paying crypto taxes is not easy though. Taxes are already a very complicated and confusing topic, but in the world of crypto, with so many different exchanges, wallets, and transactions, itâs impossible to manually calculate all gains and losses. Thatâs why you need to know how to calculate taxes on crypto by using a cryptocurrency tax calculator.
Letâs explore how to calculate your crypto taxes and also see how ZenLedgerâs cryptocurrency calculator can help simplify the process.
How Are They Taxed
You can answer How does cryptocurrency gain value? in two ways. It can work as a capital asset and earned income. This means it has two types of crypto taxes too.
Cryptos work like stocks because their prices rise and fall too. The term capital gains tax has two forms: short-term and long-term in the US. Lets see how they work for cryptocurrencies:
- Short-term capital gains You pay these for cryptos youve only held for less than a year. Also, you may deduct losses worth a maximum of $3,000. Capital losses above that amount can reduce next years taxes.
- Long-term capital gains Once youve held cryptos for more than a year, you stop paying short-term capital gains taxes and start paying long-term ones. Your tax liability will depend on your tax bracket and tax rate. If you want to learn more about this type of tax, .
Next, lets talk about how cryptos provide taxable income. This happens when you do the following things with your cryptocurrencies:
- Selling them for cash
- Buying crypto using another on an exchange platform
- Mining or confirming transactions to earn more coins
- Receiving them as payment or from an airdrop
- Earning rewards from crypto staking, depositing coins to earn more
Explaining how this type of tax works with cryptos will take a long time. Visit the IRS website to learn more about terms like cost basis and ordinary income.
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How Is Cryptocurrency Taxed
It’s not the most exciting part of crypto investing, but if you do invest, you need to know how taxes on crypto work. While cryptocurrencies are still new, the IRS is working hard to enforce crypto tax compliance.
There are quite a few ways that you can end up owing taxes on crypto, and even trading one cryptocurrency for another is a taxable event. If you don’t keep accurate records, it can be hard to piece together your gains and losses at tax time. And if you don’t pay your crypto taxes, even if it’s an honest mistake, you could end up incurring costly penalties.
This guide will explain everything you need to know about taxes on crypto trading and income. You’ll learn how to file crypto taxes, crypto tax rates, and other important details about this complex subject.
Bitcoin And Cryptocurrency Tax Software
The solution to the cryptocurrency tax problem hinges on aggregating all of your cryptocurrency data making up your buys, sells, trades, air drops, forks, mined coins, exchanges, swaps, and received cryptocurrencies into one platform so that you can build out an accurate tax profile containing all necessary data.
Once all of your transactional data is in one place, then you can start the process of reporting each transaction properly for tax purposes. This is where bitcoin tax software comes in handy.
CryptoTrader.Tax is software built to solve the tax reporting problem. It allows cryptocurrency users to aggregate all of their historical trading data by integrating their exchanges and making it easy to bring everything into one platform. Once the historical data is in the system, the tax engine auto-generates all of the necessary tax reports for cryptocurrency traders to file like the 8949.
Today, thousands of traders use CryptoTrader.Tax to securely and automatically build out their required cryptocurrency tax reports. Users can take these generated reports to their own tax professionals, or they can simply upload them into tax software like TurboTax for cryptocurrency or TaxAct.
The CryptoTrader.Tax team even partnered up with Intuits TurboTax to make the filing process seamless and fast for traders.
Filing your taxes on your bitcoin gains upfront is a much less expensive route to go rather than winding up with a letter and problem with the IRS.
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Trading Cryptocurrency For Another Type Of Cryptocurrency
Generally, when you dispose of one type of cryptocurrency to acquire another cryptocurrency, the barter transaction rules apply. You have to convert the value of the cryptocurrency you received into Canadian dollars. This transaction is considered a disposition and you have to report it on your income tax return. Report the resulting gain or loss as either business income or a capital gain .
Most Crypto Activity Is Taxed As Property And You Need To Report More Than Just Cashing Out
Theres a common misconception that you have to report crypto taxes only when you sell your crypto for fiat currency. While that is indeed a taxable event, its not the only activity that you need to include on your return.
For most people who invest and trade cryptocurrency, its taxed as property much like stocks. That means youll have to report capital gains or losses on Form 8949 for the following activities:
- Selling your crypto for cash
- Trading one cryptocurrency for another cryptocurrency
- Using cryptocurrency at a merchant as payment
- Buying an NFT with crypto.
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If You Receive Cryptocurrency As Payment For Goods Or Services
Many businesses now accept Bitcoin and other cryptocurrency payments. If someone pays you cryptocurrency in exchange for goods or services, the payment counts as taxable income, just as if they’d paid you via cash or check. You owe taxes on the fair market value of the cryptocurrency on the day you received it.
Basic Steps For Crypto Tax Filing
There are 5 basic steps involved in filing crypto taxes:
For more on each step of the process, read below.
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Taxation On The Gain From The Sale Of Crypto
Since the cryptocurrency is not yet legalised by the Reserve Bank of India , it cannot escape from taxability. An investor earning profits from the sale of cryptocurrency must pay income tax. All incomes, except exempted explicitly by the Income Tax Act, are subject to tax. Till we receive any clarification from the income tax department, investors must pay income tax on the crypto-transactions based on the nature of the transactions.
As per the standard income tax rules, the gains on the crypto-transactions would become taxable as Business income or Capital gains. This classification will depend on the investors intention and nature of these transactions.
If there are frequent trades and high volumes, gains from the cryptocurrency transactions will be taxed as business income.
However, they will be taxed as capital gains if the purpose of owning them is primarily to benefit from longer-term appreciation in value with fewer trades. The nature of classification has to be reviewed for every taxpayer, and taxpayers must take the help of an expert for accurate reporting.
Crypto Tax Calculation Example
Suppose your annual income is $55,000 and you file your taxes as single. On August 1st, you purchased $500 of BTC and sold it a year later, on July 1st for $1,500. Your gain of $1,000 will qualify for short-term capital gains at the rate of 25%, resulting in 0.25 *$1,000 = $250
Sale price of assets – Cost of acquiring assets = Short-term gains
Sale price = $1,500
Cost of acquiring assets = $500
$1,500 – $500 = $1,000
This gain of $1,000 is a short-term gain as the assets were sold within a period of 11 months.
Annual income = $55,000, and the short-term capital gains tax rate for this income is 25%.
So, tax owed = 25% * Capital gains = 0.25 * $1,000 = $250
Another example is your annual income is $35,000 and you bought $500 of BTC on August 1, 2020. If you sell it at $1,500 on August 2, 2021, you incurred a long-term capital gain of $1,000. According to the rates tabulated above, youâll have to pay 0% taxes. Thus, no federal taxes will apply.
Sale price of assets – Cost of acquiring assets = Long-term gains
The sale price = $1,500
The cost of acquiring assets = $500
$1,500 – $500 = $1,000
This gain of $1,000 is a long-term gain as the assets are sold after a period of 1 year.
Annual income = $35,000, and the long-term capital gains tax rate for this income is 0%.
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What Is A Capital Gain / Capital Loss
A capital gain is simply the rise in value of a capital asset. In the world of Bitcoin and crypto, you incur a capital gain when you sell or trade a coin for more than you acquired it for. Just like if you sold a stock or a piece of real-estate for more than you bought it for, you owe a tax on this gain.
For example, if you purchased 0.1 Bitcoin for $1000 in April of 2019 and then sold it two months later for $2,000, you have a $1,000 capital gain. You report this gain on your tax return, and depending on what tax bracket you fall under, you will pay a certain percentage of tax on the gain. Rates fluctuate based on your tax bracket as well as depending on if it was a short term vs. a long term gain.
Why Crypto Exchanges Can’t Provide Accurate Tax Forms
This is where a big problem exists within the crypto tax space.
Cryptocurrency exchanges like Coinbase, Binance, and others do not have the ability to provide their users with accurate capital gains and losses tax reports. This is not a fault of the cryptocurrency exchange itself, it is simply a product of the unique characteristics of cryptocurrenciesânamely their transferability.
Because users are constantly transferring crypto into and out of exchanges, the exchange has no way of knowing how, when, where, or at what cost basis you originally acquired your cryptocurrencies. The exchange only sees when crypto appears in your wallet.
The second you transfer crypto into or out of an exchange, that exchange loses the ability to give you an accurate report detailing the cost basis and fair market value of your cryptocurrencies, both of which are mandatory components for tax reporting.
As you can see pictured below, Coinbase themselves explains to their users how their generated tax reports wonât be accurate if any of the below scenarios took place. This affects over two thirds of Coinbase users, which amounts to millions of people.
You can read more about the âcrypto tax problemâ in our blog post: Why Exchanges Canât Report Crypto Taxes.
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Is It Possible To Do A Like
A like-kind exchange is when you swap one asset for another that is similar but does not result in capital gains or losses.
For crypto, like-kind is expressly forbidden. It can only be utilized in the real estate industry.
Because there was no clear IRS advice on whether like-kind trade is permitted for tax years 2017 and prior, a few taxpayers choose to compute their crypto using like-kind, assuming that different cryptocurrencies are equivalent assets.
Furthermore, it is uncertain whether distinct cryptocurrencies are “substantially comparable” to qualify for a like-kind transaction. The IRS may publish advice stating whether or not like-kind is permitted, with the latter requiring taxpayers to alter their returns.
According to Bloomberg, IRS officials indicated at a 2019 tax conference that pre-2018 crypto tax filings are not eligible for like-kind treatment. Official tax policy, however, has not verified this.