Bitcoin, Ethereum, Litecoin…and the list goes on. Cryptocurrencies were once only known to those making a living online, but have grown in popularity and usage in recent years. Much has been written on their origin and the technology underlying them, but questions still remain regarding the taxation of cryptocurrencies. My intent isn’t to speak for or against cryptocurrencies, but merely to speak to the taxation of cryptocurrencies.
When first created, there was some question as to how cryptocurrency transactions should be treated for tax purposes. Before long, however, the IRS cleared it up. Cryptocurrency or “virtual currency” payments are to be reported on a W-2 or 1099 when exchanged for labor and are to be included in gross receipts when received as payment for goods or services in the course of business. It is not considered a foreign currency. Holding cryptocurrency can result in a capital gain or loss similar to other capital assets like stocks and bonds. For tax purposes, cryptocurrency has the characteristics of both the US dollar and an investment. IRS Notice 2014-21 contains guidance from the IRS regarding virtual currency.
Below are some points to guide you in handling cryptocurrency in your business or personal life:
Value. Also known as basis, it is calculated by converting the cryptocurrency to dollars on the date it is received. This is done without having to actually sell the cryptocurrency. Example: A client pays me 1 Bitcoin on March 10, 2017 for a corporate tax return. On that date, Bitcoin traded at $1201.86, so I would record a payment received of $1201.86 regardless of whether I sold the Bitcoin on that date or held it beyond that date. IRS Publication 551 speaks to the basis of assets.
Held for less than a year and sold for a gain. This scenario requires you to report the gain as ordinary income on your tax return. Example: you purchase 1 Bitcoin on March 10, 2017 for $1201.86 and sell it on August 22, 2017 for $4054.49. The short term capital gain of $2852.63 must be reported as ordinary income on your 1040.
Held for less than a year and sold for a loss. In this case, you can deduct the loss against any capital gains on your tax return. You can further deduct up to $3000 of capital loss on your 1040. Any additional loss can be carried forward and applied against capital gains and/or deducted at up to $3000/year. IRS Publication 544 speaks to the tax treatment of capital assets. IRS Publication 550 addresses carrying capital losses forward. Example: you purchased 1 Bitcoin on March 10, 2017 for $1201.86 and sold it on March 25, 2017 $935.17. You have a short term capital loss of $266.69 that can be applied against capital gains or deducted on your 1040.
Held for more than a year and sold for a gain. The tax treatment of capital assets changes when held for more than a year. Instead of being taxed as ordinary income, the transaction would be taxed as a long term capital gain. Long term capital gains rates are based on your taxable income. Here is an article addressing long term capital gains rates. The majority of taxpayers would pay 0% or 15% in capital gains tax. Example: you purchased 5 Bitcoin on May 19, 2015 for $234.31 apiece, a total of $1171.55. You sold them two years later on May 19, 2017 for $1922.18 each, a total of $9610.90. You have a long term capital gain of $8439.35. If your taxable income falls in to the 25% tax bracket, you would owe 15% in capital gains tax on the $8439.35. A tax of $1265.90.
Held for more than a year and sold for a loss. The tax treatment is the same as holding it for less than a year and selling for a loss.
The above is not intended to be tax advice and could already be outdated by the time that you are reading this. There is talk on Capitol Hill of changing capital gains rates and it’s possible that the IRS will alter the way they view virtual currencies. In any case, your circumstances are unique and you should consult an accountant if you have further questions about the taxation of cryptocurrency.
