How to Calculate Your Bitcoin Taxes - The Complete Guide
Reporting your trading gains and properly completing your Bitcoin taxes is becoming increasingly important. Governments around the world are paying much closer attention to Bitcoin and other cryptocurrencies after seeing the market value go from 15 billion to 600 billion in 2017. This guide breaks down the fundamentals of Bitcoin taxes and walks through the reporting process in the United States.
Bitcoin Tax Fundamentals
According to the first and only official IRS guidance that was issued in 2014, Bitcoin should be treated as property for tax purposes — not as currency. This is true for all cryptocurrencies such as Ethereum, Litecoin, Ripple, etc. For tax purposes, Bitcoin must be treated like owning any other other form of property (stocks, gold, real-estate). This means that you are required to file your capital gains and losses realized when trading Bitcoin and other crypto’s. Failing to do so is technically tax fraud in the eyes of the IRS.
What is a capital gain?
A capital gain is the rise in value of a capital asset (an asset that is some type of investment) that gives it a higher worth than the purchasing price. Most governments collect taxes on these capital gains.
How do I calculate my Bitcoin capital gains?
Step 1: Understand what is considered a taxable event– AKA when it is that you will actually owe money to the government for a capital gain on your Bitcoin transactions.The following have been taken from the official IRS guidance from 2014 as to what is considered a taxable event:
- 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; you may also end up owing sales tax)
- Giving cryptocurrency as a gift is not a taxable event (the recipient inherits the cost basis; the gift tax still applies if you exceed the gift tax exemption amount)
- A wallet-to-wallet transfer is not a taxable event (you can transfer between exchanges or wallets without realizing capital gains and losses, so make sure to check your records against the records of your exchanges as they may count transfers as taxable events as a safe harbor)
- Buying cryptocurrency with USD is not a taxable event. You don’t realize gains until you trade, use, or sell your crypto. If you hold longer than a year you can realize long-term capital gains (which are about half the rate of short-term) if you hold less than a year you realize short-term capital gains and losses.
Step 2: Determining your cost basis
Now that it is clear when you must pay taxes, it’s important to understand the exact process behind doing so. You first must determine the cost basis of your holdings. Your cost basis is how much money you put into purchasing the property. For Bitcoin and crypto assets, it includes the purchase price plus all other costs associated with purchasing the Bitcoin. Other costs typically include things like transaction fees and brokerage commissions from the exchanges you purchase from. So to calculate your cost basis you would do the following:
(Purchase Price of Crypto + Other fees) / Quantity of Holding = Cost Basis
For example, if you invested $1000 in Bitcoin back in November of 2017, that would have bought you about 0.06 Bitcoin. Let’s say you also paid Coinbase a 1.49% transaction fee on the purchase. Your cost basis would be calculated as such:($1000 + 1.49%*1000)/0.06 = $16,915 per Bitcoin or simply $1,014.90 per 0.06 Bitcoin
Step 3: Calculate your Capital Gain/Loss
The final step in determining your capital gain or loss is to merely subtract your cost basis from the sale price of your Bitcoin.
Sale Price - Cost Basis = Capital Gain/Loss
As an example, let’s say you sold exactly 0.06 Bitcoin a month later because the price had gone up to $20,000 per coin (or $1,200 for 0.06). This would be considered a taxable event (trading crypto to FIAT currency) and you would calculate the gain as follows:
1,200 - 1,014.90 = $185.10 Capital Gain
You would pay a tax on that $185.10 capital gain.
If you are trading bitcoin a lot, keeping track of the sale price and your cost basis can quickly become tedious. CryptoTrader.Tax is Bitcoin tax software that can automatically run these calculations for you and give you an exportable report to hand over to the tax man. You can also use it to avoid having to pay an arm and a leg for a “crypto accountant” to do these same calculations on your behalf.
Determining Fair Market Value
This simple capital gains calculation gets a bit more complicated when you consider a crypto-to-crypto trade scenario (remember this also triggers a taxable event). One crucial piece of information that has been left out thus far is Fair Market Value. Let’s look at another example to gain understanding of how fair market value ties in.Let’s say you purchase $100 worth of Bitcoin including transaction and brokerage fees. That $100 currently buys about 0.01 Bitcoin. Now let’s say two months later you trade all of your 0.1 Bitcoin for 0.16 Ether. How would you calculate your capital gains for this coin-to-coin trade? Well, turns out, it depends on what the Fair Market Value of Bitcoin was at the time of the trade. Let’s say at the time of the trade, 0.01 Bitcoin was worth $160. This would make the Fair Market Value of 0.01 Bitcoin $160. You would then be able to calculate your capital gains based of this information:
160–100 = $60.00 capital gain
For that crypto-to-crypto trade, you would owe the government a percentage of your $60.00 gain.
This calculation and concept of Fair Market Value sparks a large variety of problems for crypto traders. Some traders have been trading crypto for months, possibly years, and haven’t been keeping track of the dollar value or Fair Market Value of their crypto at the time of the trade. This is information that you actually need to have to accurately file your taxes and avoid problems with the IRS. Depending on the volume of trades you have carried out, calculating gains accurately could become extremely tedious, and potentially impossible to do by hand or even with Excel if you haven’t been keeping track of Fair Market Value.
The Reporting Process
You need two forms for the actual reporting process when you are filing your taxes: the 1040 Schedule D and the 8949. The Schedule D is the IRS form on which you report your capital gains for all of your personal property--be that stocks, artwork, cars, etc. You will use the 8949 to detail each Bitcoin trade that you made during the year and the gains that you realized on each trade. Total these up at the bottom of the 8949, and then transfer the total sum onto the Schedule D. For more detail on how to report your Bitcoin on taxes, read this.
If you have a large number of trades to report, it might be useful to automate the creation of your 8949 by using CryptoTrader.Tax.
What happens if I don’t pay my Bitcoin taxes?
A lot of traders are convinced that because of the anonymous, decentralized nature of Blockchain and crypto transactions, that there is no way for the government to see or know that they are making money trading/buying/selling Bitcoin. The hard truth is that this is just not true. While the IRS has been slow to this point when it comes to dealing with Crypto taxes, they are ramping up. The IRS win against Coinbase, which required the popular exchange to turn over records for individuals who have $20,000 or more in any transaction (buy/sell/ or receive), is likely just the beginning. You will see the IRS start to get very serious when it comes to traders who don’t properly file their gains. When there is this much money on the line, the big guys typically do not kid around. The same is also true even if you are only doing wallet-to-wallet transactions. The Blockchain is a distributed public ledger, meaning anyone can view the ledger at anytime. Figuring out an individual’s activities on that ledger essentially comes down to associating a wallet address with a name. In the future, we will likely see software that is specifically built for automatically auditing blockchains. If you chose not to file your gains, you expose yourself to tax fraud to which the IRS can enforce a number of penalties, including criminal prosecution, five years in prison, along with a fine of up to $250,000.
*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.