The Ultimate Guide To Bitcoin Taxes
Reporting your trading gains and losses 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 skyrocket over the past years and into 2020. Over the past year, the IRS has sent out thousands of warning letters to investors and updated their tax guidance on virtual currencies. This guide breaks down the fundamentals of Bitcoin taxes and walks through the reporting process in the United States.
Bitcoin Taxes - The Fundamentals
According to official IRS guidance, Bitcoin should be treated as property for tax purposes — not as currency. This is true for all cryptocurrencies such as Ethereum, Litecoin, XRP, etc. For tax purposes, Bitcoin must be treated like owning any other other form of property (stocks, bonds, real-estate). This means that you are required to report your capital gains and losses realized when trading Bitcoin and other crypto’s. Failing to do so is considered tax fraud in the eyes of the IRS.
What is a capital gain? What about capital losses?
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 original purchasing price. Most governments collect taxes on these capital gains.
For example, if you bought one Bitcoin for $5,000 and then sold it one month later for $7,000, you have a $2,000 capital gain.
On the contrary, a capital loss is exactly the opposite. You incur a capital loss when you dispose of a capital asset (in this case crypto) for less money than you acquired it for. These losses actually reduce your taxable income on your tax return and therefore can be used to save you money. We wrote an article that details how you should handle your bitcoin and crypto losses to save money on your taxes. Both capital gains and capital losses from your crypto investing activity need to be reported on your taxes.
How do I calculate my bitcoin capital gains taxes?
Step 1: Understand what is considered a taxable event
A taxable event is a specific situation in which you incur a reporting liability on your Bitcoin and other crypto 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)
- Mining cryptocurrency incurs a taxable event (in the form of income)
NOT a taxable event:
In contrast, the below are not taxable events. You do not incur a reporting liability when you carry out these types of transactions:
- Giving cryptocurrency as a gift is not a taxable event
- A wallet-to-wallet transfer is not a taxable event
- Buying cryptocurrency with USD is not a taxable event. You don’t realize gains until you trade, use, or sell your crypto.
Step 2: Determining your cost basis
Now that it is clear when you are triggering "taxable events" and 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 your 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 Fair Market Value (sale price) of your Bitcoin.
Fair Market Value - 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 need to report and pay a tax on a portion of that $185.10 capital gain.
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). 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. Given this information, you would be able to calculate your capital gains:
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 their trades. This is information that you need to have to accurately report and file your taxes to 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.
Bitcoin Tax Software
If you are trading bitcoin and other cryptocurrencies a lot, keeping track of the sale price in USD and cost basis data can quickly become a daunting task. Bitcoin tax software like CryptoTrader.Tax can automatically run these calculations for you and give you a complete crypto tax report to give to the tax man. CryptoTrader.Tax also offers a tool for tax professionals working with their cryptocurrency clients.
You can easily import your historical trades from all of your cryptocurrency exchanges into the software. It will associate each trade with the historical price of that cryptocurrency and automatically build out your required tax forms. Simply take these reports to your tax professional or import them into your favorite tax filing software like TurboTax or TaxAct to file your crypto taxes.
The Reporting Process
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. Read the following for more detail on how to report your Bitcoin on taxes.
It might be useful to automate the creation of your 8949 and other tax forms by using CryptoTrader.Tax.
What happens if I don’t report 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. Unfortunately, this is not true.
While the IRS has been slow to this point when it comes to dealing with crypto taxes, the 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), and their public statement on July 2nd, 2018 explaining that the taxation of virtual currencies is one of their core campaigns for the 2018 year, shows their intent in years to come.
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 emerge that is specifically built for auditing blockchains.
Why Can't My Exchanges Provide Me With Tax Documents?
One of the fundamental features of cryptocurrency is its transferable nature—or being able to freely move it from wallet to wallet. While this transferability is one of the killer features of bitcoin, it is also the culprit behind the tax problem for exchanges.
Because users are constantly transferring crypto into and out of exchanges, the exchange itself has no way of knowing how, when, where, or at what cost basis you originally acquired your cryptocurrencies. It only sees that they appear in your account. This is true for all major crypto exchanges like Coinbase, Binance, Gemini, and others.
The second you transfer crypto into or out of an exchange, that exchange loses the ability to give you an accurate report detailing the cost basis and fair market value of your cryptocurrencies, both of which are mandatory components for tax reporting.
As you can see pictured below, Coinbase themselves explains to their users how their generated tax reports won’t be accurate if any of the below scenarios took place. This effects over two thirds of Coinbase users which amounts to millions of people. You can read more about the cryptocurrency exchange tax problem here.
The solution to the crypto exchange tax reporting problem is to aggregate all of your transactions across all of your exchanges, wallets, and cryptocurrency platforms into one unit of record. Once all of your buys, sells, trades, and transactions are in one place, you can then do the necessary capital gains and capital losses tax calculations needed for tax reporting.
This of course can be done by hand or automated by using bitcoin tax software.
Do you have any other bitcoin tax questions? Our team at CryptoTrader.Tax is happy to help answer them! We have live customer support chat agents who are standing by to answer your questions. Just send us a note!
*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.