Cryptocurrency Taxes 101: What to Know Come Tax Season
A new year has arrived! For cryptocurrency investors, that means hope for another year of growth in virtual currency markets. Unfortunately, however, it also means we need to get ready to pay taxes on our cryptocurrency profits from 2017.
Most of us have made our resolutions and decided on our aspirations for 2018, but few of us are looking forward to filing our tax returns. But being prepared is half the battle, so now is the time to begin tax planning.
It’s always a good idea to consult with a Certified Public Accountant (“CPA”) when you’re preparing your tax returns. A good CPA can help you avoid tax liability by managing your assets in a smart way. However, your regular accountant probably isn’t up to speed on the evolving landscape of cryptocurrency tax policies. If you’ve invested in Bitcoin or other virtual currencies, contact a trained cryptocurrency accountant to make sure you’re prepared for tax season.
Cryptocurrency Tax in a Nutshell
Cryptocurrencies may have started off on the fringes of the internet, but now it’s a pretty mainstream investment. Bitcoin futures are traded on the Chicago exchanges, and large institutional investors are setting up virtual currency trading desks. As cryptocurrency has become more and more popular, the Internal Revenue Service (“IRS”) has refined the details of its policies regarding tax collection and reporting requirements.
The IRS treats Bitcoin and other virtual currencies as capital assets because they are convertible into cash. So, like other capital assets, cryptocurrencies are subject to the capital gains rules. These rules apply to taxpayers who buy and sell cryptocurrencies for investment purposes, as well as people who spend virtual currencies on goods and services.
Just like other capital assets, your tax rate depends on how long you held them before you sold them, as well as the price you bought in and the price you sold out. If your capital losses on your cryptocurrency investments exceed your capital gains, you can claim the loss as a deduction on your income tax returns up to $3,000.
When you’re figuring out how to properly report your cryptocurrency gains on your 2018 income tax return, start by finding out your cost basis. Your basis is the cost you actually paid for a virtual currency when you purchased it, adjusted for any related costs. This means you can deduct commissions related to the cryptocurrency purchase, such as the percentage that Coinbase takes out of every exchange. Notably, however the cost basis for your cryptocurrency investments does not include investment-related fees. Fees accrued for cryptocurrency trades in 2017 must be listed separately on a Schedule A form attached to your returns, assuming you itemize your deductions.
When you purchase a cryptocurrency, you’ve established your cost basis. However, the asset is not actually taxed until you sell it. This is when you “realize” your gains or losses on the investment. So, if you bought Bitcoin at $12,000 and sell it for $13,000, your realized gain is $1,000 even if it dips below your initial purchase price at some time in between. Sounds simple enough, right? Unfortunately not.
When it Comes to Cryptocurrency, Things Get Complicated Quickly
Unlike stocks, which are straightforward buy-and-sell transactions, pretty much any disposition of virtual currency assets is a taxable event. Tax liability is triggered when you trade your cryptocurrency for cash or other virtual currencies or whenever it’s used to purchase goods or services. Depending on your investment and spending habits, this can make things complicated.
Contrary to the popular belief – and wishful thinking – of many cryptocurrency investors, cashing out of your cryptocurrency investments isn’t the only taxable event in the lifespan of your investment. For example, if you make a purchase using Bitcoin on Overstock.com, this is a transaction subject to capital gains tax. Tax liability also arises when you trade one virtual currency for another, which is an almost daily occurrence among the more courageous cryptocurrency investors.
Also, because the IRS doesn’t impose the same third-party reporting requirements for virtual currencies as other more highly-regulated assets, you won’t get a Form 1099 from your exchange, client, or employer at the end of the year. This means you won’t get an official report of your cryptocurrency income. Rather, it’s your responsibility as the investor’s to properly report your virtual currency gains and losses. There is very little official guidance from the IRS on virtual currency reporting requirements, so consulting with a trained cryptocurrency accountant this tax season is a very wise choice.
Federal Tax Reform Impacts Cryptocurrency Taxes
If you ask any accountant about the impacts of the 2018 tax reforms, you will likely get an exasperated sigh in response. Cryptocurrency tax policy is pretty vague as is, and adding the complexities of major tax reform only makes things even more complicated. While the full impact of the federal tax reform remains to be seen, there are a few policies that definitely impact virtual currency investors.
The recent federal tax reform changed the rules of the game for many cryptocurrency investors. For example, starting in 2018, you can no longer include cryptocurrency-related fees in your itemized deductions on your personal income tax return. This deduction is still allowed for businesses, however. The 2018 tax reforms also change the capital gains tax rates, which may greatly impact your investment decisions. Holding on to your cryptocurrency assets for another few months may save you – or cost you – thousands of dollars on your federal income tax returns.
A skilled cryptocurrency accountant can help you plan for the upcoming changes in the federal tax code, especially as they pertain to your virtual currency wallet. If you bought or sold cryptocurrencies in 2017 – or if you’ve thus far failed to report your cryptocurrency investments from prior rules – it’s a good idea to discuss your investments with a CPA that understands the ins-and-outs of cryptocurrency tax policies.
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