Filing your taxes already causes headaches for enough people. But when you throw virtual currency into the mix, that headache becomes a migraine. The IRS published the first set of instructions on cryptocurrency taxes back in 2014, but despite this, 2019 is only the second year cryptocurrency users have begun to report their earnings correctly.
To be clear, earnings in cryptocurrency are not “tax free”. The IRS may be having some difficulty understanding all your transactions and profits, but virtual currency owners still owe taxes for their activities.
Last year, just a small fraction of cryptocurrency owners reported capital gains from their investments in 2017. But this year, a lot more people are expected to report their 2018 earnings.
So here’s what you need to know about cryptocurrency taxes in the US.
Cryptocurrency is an investment property
The first thing you should know about cryptocurrency taxes is that virtual currency follows the same rules as an investment property, not an actual currency.
That means paying taxes for crypto gains is the same as for stocks, bonds, real estate, gold, and other investment properties. However, note that not everything that applies to real estate earnings also applies to cryptocurrency.
What does this mean to you? It means you need to report all operations and pay taxes when you sell, trade, or use cryptocurrencies. So, you should pay taxes every time you make capital gains and losses. These include situations like:
- Trading cryptocurrency to USD (or any other fiat currency)
- Trading cryptocurrency to other cryptocurrency or tokens
- Using cryptocurrencies to buy goods or services
- Receiving free coins through an airdrop or bonus
Here’s where it gets a little trickier. Even if you didn’t cash out anything in 2018, you may still owe cryptocurrency taxes for making acquisitions or converting Bitcoin to Ethereum, for example.
If you want to avoid a run-in with the IRS, keep accurate records of all your transactions, whether you trade cryptocurrencies for USD or other currencies. You need to report all your movements at the end of the year, together with all the gains and losses you’ve made. These should be registered by filling out and submitting Form 8949.
How to calculate gains and losses
Buying any cryptocurrency using fiat currencies isn’t a taxable event. But you need to keep a record of the value of your assets on the day you bought them. This helps you calculate gains and losses when you trade or sell.
For all your reports, calculate the value of transactions based on how much your digital coins were worth at the time of the event.
If you trade cryptocurrency for fiat, you need to calculate profit based on the value of the coins in USD. For example, if you bought $1,000 worth of Bitcoin and its price went up by 50% compared to USD, your investment would be worth $1,500 when you cashed out. So, you owe taxes on a profit of $500.
Calculating cryptocurrency taxes is hard since there are multiple ways of reporting on your transactions.
You can calculate profits and losses just like you do for stocks as ‘first in, first out’ (FIFO) or ‘last in, first out’ (LIFO). It all depends on the nature of your investment and whether you want to buy and hold digital assets for more than a year.
A word on long-term capital gains
In the US, short-term capital benefits are taxed at the normal income tax rate. Rates for long-term gains are discounted. So, if you want to pay fewer taxes, consider holding your digital coins for at least one year and a day. But remember, you should calculate the risk before making this decision, given the volatility of cryptocurrencies.
To benefit from long-term gains discounts, you need to keep accurate records that prove your ownership for the time claimed.
What about mining?
Cryptocurrency taxes resulting from mining are different. You still calculate the value of your income based on the fair market value of the coins the day they were mined. However, this is considered ordinary income whether you do this as a hobby (when it’s considered “other income”) or business (in which case you’ll need a professional to take care of your taxes).
The same applies when you receive cryptocurrency as pay for your work. You owe the income taxes based on the dollar value of the coin at the time you earned it. If you don’t cash out right away, you’ll have to calculate the market value again when you do to account for profit or loss.
Cryptocurrency tax software can help
You can find multiple crypto tax software solutions online to help you keep track of your trading history and calculate the value of your cryptocurrencies each time you buy, sell, trade, or make acquisitions.
This can be a cost-effective way of avoiding fees or tax fraud due to having too many transactions to monitor.
When you don’t pay cryptocurrency taxes
Yes, you’ll be glad to know there are some circumstances in which you don’t have to pay taxes for your activities on the blockchain!
Besides buying cryptocurrencies with USD, the other non-taxable events are wallet-to-wallet transfers and cryptocurrency gifts worth less than $15,000.
If you’re struggling with your cryptocurrency taxes, take heart. You’re not the only one. As the technology evolves, the rules will become clearer and you can be sure of keeping the taxman happy.