Cryptocurrency taxes or How much you will pay the government for a Bitcoin

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Are There Taxes on Bitcoins?

What Is a Bitcoin?

Bitcoin is a virtual currency that uses a cryptographic encryption system to facilitate secure transfers and storage. Unlike a fiat currency, bitcoin is not printed by a central bank, nor is it backed by any. Bitcoins are generated by what is called mining—a process wherein high-powered computers, on a distributed network, use an open-source mathematical formula to produce bitcoins.

It takes real high-tech hardware and hours or even days to mine bitcoins. One can either mine bitcoins or buy them from someone by paying cash, using a credit card, or even a PayPal account. Bitcoins can be used like fiat world currency to buy goods and services.

Key Takeaways

  • Bitcoin is a decentralized cryptocurrency used like fiat currency to buy and services.
  • In the US, the IRS considers bitcoins as assets, rather than currency.
  • US taxpayers must report bitcoin transactions for tax purposes.
  • If bitcoins are held for less than one year before the transaction, short-term capital gains are applied.
  • If bitcoins are held for more than one year before the transaction, long-term capital gains are applied.

Understanding Bitcoins

Bitcoin is now listed on exchanges and has been paired with leading world currencies, such as the US dollar and the euro. The US Federal Reserve acknowledged the growing importance of bitcoin when it announced that bitcoin-related transactions and investments cannot be deemed illegal.

At the start, bitcoin’s attractiveness was attributed partly to the fact that it wasn’t regulated and could be used in transactions to avoid tax obligations. The virtual nature of bitcoin and its universality also make it harder to keep track of in cross-country transactions.

Also, government authorities around the world soon realized that bitcoin attracted black marketers who could make illegal deals. Naturally, bitcoin couldn’t escape the tax authorities’ radars for long.

Bitcoin Taxation

Around the world, tax authorities have tried to bring forth regulations on bitcoins. The US Internal Revenue Service (IRS) and its counterparts from other countries are mostly on the same page when it comes to the treatment of bitcoins. The IRS has said that the bitcoin should be treated as an asset or an intangible property and not a currency as it is not issued by a central bank. Bitcoin’s treatment as an asset makes the tax implication clear.

The federal agency said in July 2020 that it is sending warning letters to more than 10,000 taxpayers it suspects “potentially failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly.” It warned that incorrect reporting of income can result in penalties, interest, or even criminal prosecution.

The IRS has made it mandatory to report bitcoin transactions of all kinds, no matter how small in value. Thus, every US taxpayer is required to keep a record of all buying, selling of, investing in, or using bitcoins to pay for goods or services (which the IRS considers bartering).

Because bitcoins are being treated as assets, if you use bitcoins for simple transactions, such as buying groceries at a supermarket, you will incur a capital gains tax (either long-term or short-term depending on how long you held the bitcoins). When it comes to bitcoins, the following are different transactions that will lead to taxes:

  • Selling bitcoins, mined personally, to a third party
  • Selling bitcoins, bought from someone, to a third party
  • Using bitcoins, which one may have mined, to buy goods or services
  • Using bitcoins, bought from someone, to buy goods or services

Scenarios one and three entail mining bitcoins, using personal resources, and selling them to someone for cash or equivalent value in goods and services. The value received from giving up the bitcoins is taxed as personal or business income after deducting any expenses incurred in the process of mining.

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Such expenses may include the cost of electricity or the computer hardware used in the mining of bitcoins. Thus, if able to mine 10 bitcoins and sell them for $250 each, you have to report the $2500 as taxable income before any deductible expenses.

Scenarios two and four are more like investments in an asset. Let’s say bitcoins were bought for $200 each, and one bitcoin was given up in exchange for $300 or an equivalent value in goods. The investor has gained $100 on one bitcoin over the holding period and will attract capital gains tax (long-term if held for more than one year) on the excess.

Short-Term and Long-Term Capital Gains

If bitcoins are held for less than a year before selling or exchanging, a short-term capital gains tax is applied, which is equal to the ordinary income tax rate for the individual. However, if the bitcoins were held for more than a year, long-term capital gains tax rates are applied.

In the US, long-term capital gains tax rates are 0% for people with taxable incomes less than $78,750, 15% for single tax filers with taxable incomes between $78,750 and $434,550 ($488,850 for married couples filing jointly and widow(er)s, $244,425 for married couples filing separately, and $461,700 for heads of household), and 20% for those with taxable incomes that exceed the 15% threshold.

Thus, individuals pay taxes at a rate lower than the ordinary income tax rate if they have held the bitcoins for more than a year. However, this also limits the tax deductions on long-term capital losses one can claim. Capital losses are limited to total capital gains made in the year plus up to $3000 of ordinary income.

Special Considerations

Taxation on bitcoins and its reporting is not as simple as it seems. For starters, it is difficult to determine the fair value of the bitcoin on purchase and sale transactions. Bitcoins are very volatile and there are huge swings in prices on a single trading day.

The IRS encourages consistency in your reporting. If you use the day’s high price for purchases, you should use the same for sales as well. Also, frequent traders and investors could use “first-in, first-out” (FIFO) or “last-in, first-out” (LIFO) accounting techniques to reduce tax obligations.

Crypto and bitcoin taxes in the US

Did you sell, use, or convert crypto? If so, you may owe taxes if you’re a US taxpayer. Here’s a look at what that could mean, the steps you may have to take, what forms you’ll need, and how gains and losses might affect your taxes.

First, let’s get this out of the way.

Coinbase doesn’t provide tax advice. We put this guide together for informational purposes only and it shouldn’t be considered tax advice or an individualized recommendation. Please consult a tax-planning professional regarding your personal tax circumstances.

The million- dollar crypto question

1.1 Do I have to pay crypto taxes?

At Coinbase, we see crypto as the foundation for tomorrow’s open financial system — but it’s also a part of today’s traditional one. To answer the many questions on crypto and taxes, the IRS has issued crypto tax guidance.

In previous tax seasons, we received a lot of questions from crypto newbies and experienced customers alike. We get it — paying bitcoin taxes and other crypto taxes can be confusing. While we can’t give tax advice, we want to make crypto easier to buy, sell, and use. This guide is our way of helping you better understand your 2020 crypto tax obligations.

There’s a lot of conflicting content out there, but make no mistake: you are required to report gains and losses on each cryptocurrency transaction or when you earn cryptocurrency, even if there is no gain or loss or the gain or loss is not material. The IRS holds you responsible for reporting all income and transactions whether you receive a tax form from a crypto exchange or not. Exchanges like Coinbase provide transaction history to every customer, but only customers meeting certain mandated thresholds will also receive an IRS Form 1099-K.

One quick note if you’re a non-US investor: crypto taxes are treated differently country-to-country. This guide only covers the US. Unless you happen to have some US tax obligations (this is rare) be sure to consult your local country tax advisor to confirm your tax reporting obligations at your home jurisdiction.

In a nutshell.

All crypto sells, conversions, payments, donations, and earned income are reportable by US taxpayers

The reason that buying and selling crypto is taxable is because the IRS identifies crypto as property, not currency. As a result, tax rules that apply to property (but not real estate tax rules) transactions, like selling collectible coins or vintage cars that can appreciate in value, also apply to bitcoin, ethereum, and other cryptocurrencies.

To no one’s surprise, the IRS isn’t kidding around. Failure to report income, including income from the sale of crypto, could result in interest on unpaid taxes and penalties. Please consult with a tax-planning professional regarding your individual reporting obligations.

With all that in mind, here’s our list of five steps you can take to help you understand if you may need to pay crypto taxes, how to determine the amount, and what forms you may need. Let’s dive in.

Steps to take

2.1 Determine if you owe crypto taxes

Even if you’re in the “Just HODL it” camp, it’s worth evaluating your crypto transactions to determine if you may owe taxes.

What’s taxable

In short, a lot. Here are some examples of taxable crypto events:

Selling crypto for cash

In other words, realizing the gain on your crypto property (don’t forget losses could help with your tax bill)

The Tax Treatment Of Bitcoin And Other Cryptocurrencies

At the beginning of 2020 Bitcoin was trading at $968. During the year it grew to a high of $19,783. News stories sparked many to ask, “Should I invest in Bitcoin?” More recently Bitcoin’s price had dropped back to $6,511 and the interest subsided.

For some users, Bitcoin is a way to avoid government intrusion and illegally evade paying taxes. Most Bitcoin owners, however, want to comply with IRS regulations.

The IRS classifies all cryptocurrencies as property. Buying Bitcoin is not a taxable event. But using Bitcoin to buy something else is considered a sale of Bitcoin and selling property for more than you purchased it for is a taxable event. If you “sell” some Bitcoin at a profit that you purchased within the last year, you will have to report short term capital gains on your tax return and pay ordinary income tax rates. If you sell a trade lot that you have held at least a year, you may only have to report long term capital gains which are taxed at a lower rate.

Selling Bitcoin at a loss will generate short or long term capital losses which can be used to offset capital gains. But buying any Bitcoin within 30 days before or after selling Bitcoin for a loss may generate a wash sale and then the loss must be folded back into the purchase.

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The IRS relies upon the taxpayer to correctly track and pay tax on Bitcoin and other crypto currencies. Even if the IRS doesn’t know about your Bitcoin activities you are still responsible for complying with the tax code.

Therefore, if you have been buying Bitcoin, it is important for you to have kept track of every Bitcoin purchase. Each purchase is considered a trade lot. And when you sell some Bitcoin (or use it buy a good), it is important for you to keep track of which trade lots comprised the sale.

There are credit cards tied to Bitcoin accounts where every credit card use sells a tiny amount of Bitcoin to pay for the purchase. But every time you use such a card it is a taxable event which must be tracked. Other credit cards offer Bitcoin as the rebate rewards for using the card. Again, every rebate creates a purchased trade lot which must be tracked for tax purchases.

Getting paid in Bitcoin is even more confusing. If you accept Bitcoin for services you have earned income. You owe ordinary income taxes. You also owe self-employment taxes. The same is true if you are mining Bitcoin. Mined Bitcoin must be valued as income at a fair market value the day it is mined. Once the Bitcoin is mined and you have paid income tax, it enters your inventory as its own trade lot. Any subsequent gains are taxed at long or short term capital gains tax rates.

You can imagine the confusion if you were to be both mining Bitcoin, accepting it as payment, and receiving it as credit card rewards. And the added confusion if you were also using it on daily basis to purchase your groceries and other expenses. Nearly every transaction is both taxable and potentially a wash sale.

For a currency intended to make money simple and easy, IRS regulations make it a nightmare of compliance issues.

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