Last Updated on April 17, 2024 by Ben
When you’re looking to invest in Bitcoin, it’s essential that you’re aware of the tax implications. ‘When Must You Pay Taxes on Bitcoin?’ is a question that many people ask themselves when trying to gauge out how to invest their money. This blog post will discuss what Bitcoins are classified as by the IRS and how it affects your taxes.
What You Have to Know About Paying Taxes on Bitcoin
The IRS defines cryptocurrency as “digital currency, or a “digital representation of value.”
What does this mean? Technically, you can’t touch it, and you’ll never be able to put it in your wallet. It was invented about ten years ago and has grown in popularity over the last few years.
Cryptocurrency is a great way to send money without the need for banks or other third parties. The blockchain makes it possible to transfer funds quickly and securely – bringing you one step closer to financial freedom.
Crypto is on the IRS’s Radar
A lot of people who own virtual currencies are unknown, but the leading U.S. cryptocurrency exchange Coinbase had an estimated 11 million users at the end of October 2017.
While traditional investments require a 1099 form, which is sent to the IRS and helps you keep a record of your holdings and tax obligations, virtual currencies do not always come with such forms. For example, Coinbase will provide these for certain business customers or receive at least $20k in cash from 200 transactions related to their virtual currency sales.
Without sufficient documentation, the IRS can’t enforce its rules.
Recently, few people have told the IRS about their crypto gains. Only 802 Coinbase users inform the IRS about bitcoin gains in 2015, even though there were 2.9 million Coinbase users in December of that year.
Lately, the IRS has steps to identify people who are profiting but not reporting their income.
Recently, the IRS summoned records from Coinbase, and a court has ruled that the company must disclose identifying information of any users who meet certain criteria.
Even if you do not use Coinbase often, you are still obligated to report it. And the IRS can examine your tax return. In 2016, the IRS checked 0.6% of 193 million tax returns, or about 1.2 million.
You Owe Taxes if You Sold or Spent Crypto
Bitcoin and other digital currencies are to be treated as property, not currency as per the IRS.
If you did anything with your bitcoin last year, like selling it, giving it to a friend, or using it to buy something, you are making a taxable event. You are then responsible for paying taxes on the appreciation of the virtual currency from the time you bought it until when you sold (or spent it).
The amount of tax you have to pay on your virtual currency depends on how long you had it. If you had it for over a year, then it is taxed at capital gains, and if you had it for less than a year, then it’s taxed at ordinary income. Use form 8949 to report that information.
You Don’t Owe Taxes if You Bought and Held
If you buy and hold onto your Bitcoin until the end of this fiscal year, then you don’t have to pay taxes on your asset for its appreciation. In a similar way as stocks or bonds that pay capital gains tax when they’re sold, you only have to pay taxes after selling or exchanging any virtual currency.
If you are just holding onto your Bitcoin but haven’t exchanged it yet, there is no triggering of gain that will show up on your tax return.
It’s Smart to Keep Your Own Records
If you frequently use or buy cryptocurrency, it is important that you keep detailed notes on the changes in prices of both buying and selling.
If you do not have your cost basis down, then you will owe taxes on the gross proceeds and not what is sold.
If you have, say, a cryptocurrency that is worth $5 and then it becomes worth $10, the government will only tax you for the difference–$5. But if you do not know how much it was originally worth or cannot prove that you bought it at $5, they will tax you for the amount of money it was worth when you sold it–$11.
So, make sure to keep complete records of every cryptocurrency transaction and include the date, price purchased, or sold. Also, keep detailed records on what type of currency was used for the purchase (Bitcoin) and how much was bought/sold for.
If you wish to keep track of your transactions, you should download reports from the websites that you use. You can keep them when you need them.
Taking Losses
Historical data from CoinMarketCap.com shows that the price of bitcoin has been steadily increasing since January 2017.
However, if you did suffer a loss on an investment in cryptocurrency that year – whether bitcoin or another type of digital asset – those losses can be used to offset any taxes you owe for investments that had successful returns.
What You Have to Report on Your Tax Return
Taxes are one of life’s only certainties, and cryptocurrency is no exception.
If you make or lose money on your investments, you need to report it on your taxes. In the past, people who hold cryptocurrencies might not have reported their income and paid the taxes they owed. According to CNBC, in 2019, the IRS sent letters to more than 10,000 taxpayers who had crypto transactions and might not have reported them.
This year, when you fill out your tax form for 2020, the IRS will ask about cryptocurrency. It will be in the section where you put your name and address. There is a question that says: “At any time during 2020, did you receive or sell any cryptocurrency?” Even if you only held it but didn’t sell it or sold it and didn’t report the income, you should answer yes.
Income and Gains
If you purchased any cryptocurrency with the intent to invest in it by either buying or selling it, then all your capital gains and losses would be reported on Schedule D of Form 1040.
If you made money on crypto and held it for one year or less, your taxes will be higher because you will have to pay income taxes. The tax rate depends on what bracket of income you are in.
How Using Bitcoin Can Affect Your Taxes
Bitcoin can come with surprises when it comes to money and taxes, but you should educate yourself on the rules.
Buying, selling, mining, or spending cryptocurrencies like Bitcoin may be taxable. If you get paid in bitcoins or other cryptocurrencies, the money is also taxable income. You will need to report these transactions in U.S. dollars, which means changing the value of your crypto to dollars when you buy it, sell it, mine it, or use it.
Here is how using bitcoin can affect your taxes:
Bitcoin and Other Cryptocurrencies are Property
In 2014, the IRS ruled that Bitcoin and other “convertible virtual currencies” must be treated as property for tax purposes.
Bitcoin is treated property by the IRS and accumulates taxation implications at different points in time. Here is what it means:
- If you acquire a bitcoin, it is taxable immediately, though you do not need to sell the currency to create a tax liability.
- If you sold or traded bitcoin by cashing it on an exchange, or if you purchased goods and services with it, you owe taxes when the realization price is greater than what you paid for the bitcoin. You may have a capital gain that’s taxed at either short-term or long-term rates.
Record-keeping is Key
In order to remain on the right side of the law, you must keep careful track of your cryptocurrency activity.
- When you mine or buy bitcoin, keep records of how much it was worth. Then make a note when you use or sell it. That information will let you calculate your taxes.
- If you were buying and selling stocks, a 1099-B form would be available to show the cost basis of your transaction. With Bitcoin, you might not receive one, which is why many people have no idea they’re liable for bitcoin taxes. It is possible to have a problem with the IRS. You are conditioned by getting 1099 to know when you have had a taxable event and what that taxable gain is. You won’t always get this information from an exchange with bitcoin. So many people just aren’t informed in the way that they are used to.
- A form 1099-K might be issued if you have done more than $20,000 in transactions or 200 transactions. If you do not meet both conditions, then you do not need to worry about the tax.
- If you are not paying taxes on your gains, it might be because you made an honest mistake. But the IRS will not forgive you if they find out about this. They have even sued someone who didn’t report their bitcoin gains.
If Your Bitcoin is Stolen, Tough
In the past, if you were robbed of your bitcoin, you might be able to subtract it as a robbery loss on your taxes. But in the new tax rules, people can’t deduct personal theft losses.
Yet another new tax rule negatively impacts owners of digital currency. Besides property, most things can be traded for other properties without immediate tax implications–it’s called a like-kind exchange.
With the tax law changes, bitcoin owners wanted to know whether they could engage in like-kind transactions with other cryptocurrencies. The advantages of this arrangement were unclear under the old regime. Unclear was whether one crypto is like-kind to another with the new tax reform comes into effect on personal goods prohibiting the use of this practice.
There is a Bit of Comfort for Bitcoin Taxes
Crypto taxes can be difficult, but there are some opportunities to deduct losses from bitcoin transactions. You can get tax deductions for losses on bitcoin that you have bought and sold in the same year as with stocks and bonds. You cannot get a deduction of more than $3,000 in any one year.
Bitcoin changes a lot. Sometimes you can win, but sometimes you lose money. If you have lost money on bitcoin or any other cryptocurrency, put it in your taxes and see if it will lower the amount of tax that you owe.
Bitcoin taxation is an important issue for bitcoin owners.
When Do You Pay Taxes on Bitcoin?
The IRS says that Bitcoin is treated as property and is subject to general tax principles. If you are paid in Bitcoins, then the fair market value of the Bitcoins must be included in your gross income. Transactions using digital currency should be reported in U.S. dollars.
If you sell Bitcoin, you might have a gain or a loss. This is because Bitcoin is considered property for tax purposes. Gains are income, and income is taxable, even if it’s paid in virtual currency.
Along with other types of property, you would acquire it first by trading cash for the asset. You then own the asset for a period of time and might eventually sell it, trade it, or otherwise dispose of it at a later date. A tax on capital gains is due in this case.
When a property is disposed of, four things will happen:
- Income is realized from any gain.
- The gain on a sale of an asset is measured by the change in dollar value between what you paid for it and your selling price.
- Bitcoin is taxed based on its classification. Short-term gains are taxed at a lower rate than long-term gains.
- Computing a gain or loss on the disposition of Bitcoin requires you to provide information related to cost or another basis, proceeds from a sale, and the date the property was sold on Schedule D and Form 8949.
What Happens If You Don’t Pay Taxes?
If you don’t pay your taxes for Bitcoin, the IRS may not like it. Even if you didn’t know that you were supposed to, the IRS would still want their money.
First, the IRS can always find out about your activities. Bitcoin deals are permanently stored in the Bitcoin network, which is public.
If you don’t pay your taxes, you might be charged interest and lose money. You may also be charged interest at a rate of 0.5% on the amount of tax that is owed up to a max of 25%.
The IRS can do many things to collect money. They can put a lien on your assets, or they can make money from your bank account or your paycheck.
Summary
The IRS is cracking down on cryptocurrency taxation. It’s, therefore, necessary for people to maintain records of their transactions and remain prepared for investigation, tax payments, and any possible fines.
It might seem like a slight difference, but it’s not. The difference between property and currency determines how Bitcoins are taxed.
In order to be prepared for investigation or any possible fines, people should maintain records of their transactions and remain knowledgeable about the current situation with crypto taxation.