Bitcoin has been one of the highest performing asset classes in 2019. Starting the year valued at just $3,700 per coin, Bitcoin has increased more than 180% and at the time of this writing is valued at over $10,000 per coin. This price appreciation has Bitcoin traders and investors sitting on substantial capital gains for the year. These gains have many investors asking the dreaded tax question: Do I owe taxes on my bitcoin gains?
The short answer to this question is yes. This guide walks through exactly how cryptocurrencies like bitcoin are treated from a tax perspective. It will also demonstrate how software tools can be used to automate the entire tax reporting process.
Bitcoin and other cryptocurrencies are treated as property in the eyes of the law, not as currency. This means that bitcoin is subject to capital gains and losses tax rules just like other forms of property-stocks, bonds, real estate etc.
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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.
When do I Trigger a Capital Gain or Loss Reporting Requirement?
A taxable event is simply a specific action that triggers a tax reporting liability. In other words, whenever a ‘taxable event’ happens, you trigger a capital gain or capital loss that needs to be reported on your tax return. Taxable events also apply to cryptocurrency. The following have been taken from the official IRS guidance from 2014 as to what is considered a taxable event in the world of crypto. If any of the below scenarios apply to you, you have a tax reporting requirement.
- Trading cryptocurrency to fiat currency like the US dollar is a taxable event
- Trading cryptocurrency to cryptocurrency is a taxable event (you have to calculate the fair market value in USD at the time of the trade)
- Using cryptocurrency for goods and services is a taxable event (again, you have to calculate the fair market value in USD at the time of the trade)
- Earning cryptocurrency as income is a taxable event (from mining or other forms of earned cryptocurrency)
So in the example above, you trigger a taxable event with your sell of your $2,000 bitcoin. You also would trigger a taxable event if you traded that $2,000 bitcoin for another cryptocurrency, say 5 ETH.
What Does Not Trigger a Taxable Event?
- Giving cryptocurrency as a gift is not a taxable event
- A transfer is not a taxable event (you can transfer crypto between exchanges or wallets without realizing capital gains and losses)
- Buying cryptocurrency with USD is not a taxable event (you don’t realize gains until you trade, use, or sell your crypto)
Again looking at the example above, let’s say you never sold or traded your $2,000 worth of bitcoin. Just continuing to hold the asset does not trigger a taxable event. You only incur the capital gain when you trigger a taxable event.
How Do I Actually Report My Gains On My Taxes?
List all of your taxable events, i.e. cryptocurrency trades/ sells, onto Form 8949 (pictured below) along with the date you acquired the crypto, the date sold or traded, your proceeds (Fair Market Value), your cost basis, and your gain or loss. Once you have each trade listed, total them up at the bottom, and transfer this amount to your 1040 Schedule D. Include both of these forms with your yearly tax return.
For a detailed walkthrough of the reporting process, please review our article on how to report cryptocurrency on your taxes.
Why Can’t My Cryptocurrency Exchanges Provide Me With Accurate Tax Reports?
This is where the big problem exists.
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. It only sees that they appear in your account.
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 won’t be accurate if any of the below scenarios took place. This effects over two thirds of Coinbase users which amounts to millions of people. You can read more about the cryptocurrency tax problem here.
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 Intuit’s TurboTax to make the filing process seamless and fast for traders.
It’s no secret that the IRS is starting to crackdown on crypto and bitcoin tax compliance. As seen in July 2019, the agency has sent more than 10,000 warning and action letters to suspected cryptocurrency holders and non-compliant persons. These include IRS Letter 6174 and 6173 as well as letter CP2000 for cryptocurrency.
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.
Disclaimer — This post is for informational purposes only and should not be construed as tax or investment advice. Please speak to your own tax expert, CPA or tax attorney on how you should treat taxation of digital currencies.