Bitcoin Taxes –

by Joff Paradise | 04 Oct, 2021 11:10 am | News

Bitcoin Taxes

Bitcoin Taxes

Overview

As the fourth quarter of the year begins not many are thinking about taxes, but they should be. Understanding Bitcoin and altcoin taxes and your obligations for reporting trade gains and losses has become even more important. The thing to realize is that cryptocurrency taxation needs to be taken seriously. Most exchanges now require KYC (know your customer) input and will provide the IRS with your taxpayer ID and historical transaction records. The time to assess and prepare for tax obligations is now vs. later.

For the sake of simplicity, this post is written about U.S. tax obligations, so be sure to check the specific tax requirements for your country. Unlike bitcoin, we tend to think in terms of dollars and cents when it comes to taxes, but it really makes little difference to the IRS. Your Bitcoin investments are the same as any other capital asset since the virtual currency is considered to be property.

That said, the House Ways and Means Committee released a summary report indicating plans to treat crypto more like stocks in the future. With crypto currently classified as property, losses on crypto holdings are treated much differently. Should this proposal pass, investors have until Dec. 31 to reduce their 2021 tax bill by taking advantage of tax-loss harvesting loopholes that currently exist. That is to sell at a loss and buy back bitcoin at a lower price in an attempt to “look as poor as possible.”

The same principles currently apply to bitcoin as when buying or selling a home. A capital asset is anything you own, such as your home, cryptocurrency, stocks, bonds, etc. The basis is exactly the amount you paid to purchase said property, less any fees. Capital gains and losses are the profit or loss incurred for said property and remain “unrealized” until you actually sell the property. Once you sell your crypto, the gains or losses become “realized” and there are tax implications. In the U.S. there are indications that the current administration intends to try and pass new law to tax “unrealized” gains. While it remains to be seen whether such outlandish new tax laws would pass, the importance of keeping accurate records is all the more important.

Trading Gains & Losses

Since the IRS has determined that bitcoin is considered property, not currency, accrued long-term gains and losses will be taxed at each investor’s applicable capital gains rate. Long-term means the property or crypto has been owned for one year or longer before being converted to fiat. This is good news as opposed to gains and losses being taxed at ordinary income rates, which is the case with short-term gains and losses.

The IRS caps net capital losses at $3,000 per year for married and single filers on personal tax returns. This limit has been effective for nearly 40 years, and it means that large short-term trading losses may have to be carried forward for years. If you have suffered trading losses it is important to understand the write-off is not the same as with “foreign currency” losses against ordinary income.

Fair Market Value

The next issue to tackle is the cost base. The IRS requires the reporting of the fair market value of bitcoin holdings for the date that the currency was received. One may determine this fair market value using a daily high or low value from exchanges, but it is important to be consistent. In other words, if you use a daily high from one exchange, don’t use a daily low from a different exchange to artificially reduce your tax liability. Of course, there is currently no way reporting can be 100% consistent across these lines.

Bitcoin taxes start to get complicated when it comes to cost bases. Traders have the right to calculate their cost bases using one of several different methodologies.

  1. FIFO – First-In-First-Out
  2. LIFO – Last-In-Last-Out
  3. Specific Share Identification (commonly used in stock trading)

Depending on which method is used, a major impact on the calculations of both long- and short-term capital gains could be the result. For example, if you bought coins more than a year ago and used the buying price as the cost base, you would benefit from a lower long-term capital gains rate. You could also sell the shortest-held bitcoins and realize a lower nominal gain but be taxed at a higher capital gain rate. Some exchanges automatically incorporate FIFO or LIFO for investors, with no regard to which may be the most tax-friendly method.

As an investor, you may prefer to sell off bitcoins purchased at a different time as a means of writing off ordinary income. Then you might sell a different lot in order to realize a smaller long-term capital gain. These legal personal accounting methods could result in significant tax savings. However, this level of sub-accounting is not implemented on major exchanges, and it is wise to consult professional tax advisors.

eCommerce Bitcoin Taxes

To complicate the matter of bitcoin taxes further, suppose you buy a cup of coffee from a vendor accepting bitcoin. Doing so would constitute a gain or a loss, and if you are a long-time investor having seen bitcoin value rise, there would be a significant capital gain tax. The IRS has deemed there is currently no exemption for “de minimis” property gains or losses as there are when using foreign currencies. The IRS requires that the bitcoin investor keep track of each incremental capital gain, and report them via a Form 1099-B come tax time.

Donations, Tips, and Gifts

Making donations to charities in bitcoin can present a significant tax liability and a professional tax advisor should be consulted to ensure the best outcome. There is a difference regarding tax liability depending on how the donation is presented to the charity. If one were to sell the bitcoin being donated, either a 15% or 25% tax liability would be realized. The donation is considered tax-exempt and can be used to offset the liability. It could be more tax-favorable for the donor to give the charity bitcoins directly, which had been held longer than a year. The IRS allows donors to write off the entire fair market value of the donated property held for over a year (up to 30% of adjusted gross income) without stipulating a capital-gains tax.

The recipient of a gift is usually exempt from taxes for that gift, although that may not always apply when it comes to digital currencies. The issue is that gifts of property which realize a capital gain or loss upon sale are taxable, so keeping track of all the cost bases for different donations can get complicated. Whenever a gift is converted into cash or used to buy something, it is a taxable event.

Bitcoin Taxes on Lost, Stolen or Hacked Coins

What about lost, stolen or hacked bitcoins? Such losses are governed by Section 165 of the tax code. Individual losses are subject to a $100 floor and are deductible, but only to the extent that the taxpayer has a total loss for that year in excess of 10% of adjusted gross income. An investor that loses $20,000 worth of bitcoin but realized $10,000 in capital gains, would be entitled to claim a loss for the tax year in which the loss occurs and pay $1,500 in capital-gains taxes. Should your private keys be lost, stolen, deleted, destroyed, or damaged – you will not be able to write off the losses.

Bottom Line

Whether you’re interested in cryptocurrencies as an investor or trader, it pays to learn about the tax implications and stay on top of changes in order to make wise decisions. No gains are worth the interest, penalties, and stress of having the IRS on your case.

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