Trading cryptocurrency has become easier than ever, thanks to the development of sophisticated exchange platforms and new, user-friendly storage options. Yet there is one issue that can prove challenging for even relatively advanced traders: Cryptocurrency and taxes.
Given that the penalties for failing to accurately track, file, and pay taxes on cryptocurrency gains can be substantial, it’s vitally important that traders are equipped with up-to-date tax information.
With that in mind, let’s take a closer look at what you need to know about how to report cryptocurrency on taxes. You can also reference our latest article we did with CryptoTrader.tax.
This is one of the most common questions among digital currency traders. If you’re in the United States, the short and simple answer is “yes” — cryptocurrency gains and losses must be reported on your taxes. Determining how to pay taxes on cryptocurrency — and how much you owe — is not so simple, however.
In the eyes of U.S. tax authorities, Bitcoin and other digital assets are not considered currencies, but rather property. Like stocks or real estate, cryptocurrency is a taxable asset that must be accounted for at the end of the year. Digital currencies are treated this way, in part, because they are typically used as investment vehicles, rather than a medium of exchange.
This has significant implications for those who buy and sell cryptocurrency. Unless you purchase your coins and tokens with the intention of holding them long-term, you need to be aware of the tax rules that govern any sale or trade of cryptocurrency. If you make any profit or sustain any loss from the sale of a digital asset, it has tax implications.
Because Bitcoin and other digital assets are treated as property by the IRS, they are classified as capital assets. This means that they are subject to U.S. capital gains taxes.
There are two forms of capital gains tax: Short-term and long-term. Short-term capital gains tax applies when an asset is held for 12 months or fewer. This is taxed at the same rate as your regular income. So, for example, if your income tax rate this year were 25-percent, any sale of a digital currency that you’ve held for less than a year would be taxed at 25-percent.
Long-term capital gains tax applies for assets held longer than 12 months, and the rate is variable. In 2018, long-term capital gains are taxed at zero-percent, 15-percent or 20-percent, depending on your taxable income and filing status. In many cases, investors will pay less in taxes by using long-term capital gains.
For example, a day trader who makes hundreds or thousands of Bitcoin trades each year — and who has a 30-percent income tax rate — would lose nearly one-third of any profits accumulated during the year to short-term capital gains tax. Someone who buys Bitcoin and holds it for a year could theoretically pay nothing in capital gains tax, assuming they earn less than $38,600 per year in regular income — the 2018 threshold for the zero-percent long-term capital gains bracket.
Let’s take a closer look at the scenarios under which cryptocurrency taxes would need to be paid. First, the act of trading digital currencies would qualify. Any profit or loss on a trade is a taxable event. Additionally, selling cryptocurrency for cash (whether over the counter or to a friend) also triggers a taxable event, assuming there is a profit or loss.
If you accept cryptocurrency in exchange for goods or services — and that cryptocurrency goes up or down in value — that registers as a taxable event. The same thing applies to selling cryptocurrency to purchase items.
There are, however, some methods one can employ to reduce the tax burden associated with trading digital currencies. Margin trading, for example, allows you to maintain your core assets while deferring the capital gains taxes that would be triggered by a sale. This allows traders the flexibility to exploit developing market opportunities, without having to worry about steep, short-term capital gains taxes.
If you’re a crypto trader, you should also be aware that the IRS allows you to reduce your taxable income by deducting your losses. There is, however, a $3,000 maximum to this income reduction as of 2018. If you day trade for a living, you may also be able to deduct your trading expenses (establishing and claiming a home office for your business, for example).
Because Bitcoin was the first functional digital currency there was no real precedent for how cryptocurrencies would be treated under tax laws.
In the immediate aftermath of Bitcoin’s creation, there was little guidance on tax regulation, given Bitcoin’s newness, its obscurity and its lack of value. Bitcoins were initially trading for a few pennies, mostly among cryptography and computer hobbyists.
Once the popularity and value of Bitcoin began to soar, the regulatory landscape began to take shape. In 2013, Germany declared Bitcoin a unit of account and deemed it subject to capital gains tax. The following year the IRS issued Notice 2014-21, which provided guidance on tax issues surrounding virtual currencies and established that cryptocurrencies in the U.S. were subject to capital gains taxes.
In October 2019, the United State’s Internal Revenue Service (“IRS”) provided official guidance on cryptocurrency taxation, which states that cryptocurrencies, including Bitcoin, Etherium, Litecoin, XRP, and so on should be treated as property for tax purposes, as opposed to currency. What this means for U.S. consumers is that property such as stocks, real-estate and gold is now treated the same as cryptocurrency. When selling stocks, you are expected to report your capital gains and losses, and now the same applies to cryptocurrency. Cryptocurrency tax avoidance goes in breach of IRS regulations. Transactions undergo capital gains tax and that must be reported on Form 8949, the same applies to cryptocurrencies.
Regarding enforcement, cryptocurrency is treated just like any other asset by the IRS. Any trader or investor is expected to accurately report any taxes owed and pay all due taxes by the annual deadline.
Failure to do this can lead to significant sanctions, including fines and penalties. For more serious cases, the IRS may pursue tax evasion charges, meaning that jail is also a possibility.
In order to ensure this never happens, it’s incumbent upon traders to keep accurate records. This means detailing every trade or transaction made. This includes all trades on exchanges, all third-party sales, and trades and all transactions.
If you’re a day trader, that can mean compiling data for thousands of separate trades. Fortunately, most exchanges allow traders to print out a record of all trades. Additionally, advanced portfolio tracking tools can help you track trades from multiple sources with ease. This information is critically important, as it can help you (or a third-party tax professional) accurately calculate your year-end taxes.
Working with a tax professional is often a smart move for most traders and investors, as the high volatility of the digital currency market makes it difficult to track profits and losses with precision. Additionally, working with a professional can help ensure that you receive the tax advantages to which you’re entitled while avoiding the kind of mistakes that can lead you to tax trouble.
Taxes on cryptocurrency trading and transactions can be a difficult subject for even experienced traders and investors. By understanding the information we’ve outlined above, you can help ensure that you stay on the right side of the law.
Our sophisticated Haas trading platform uses advanced technology to help keep your trades, gains, and losses in order so you’ll be more prepared when tax time comes.
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