Even if Bitcoin prices have taken a bit of a tumble this year (down 75% from a high peak in January), everything in investing is a matter of timing and perspective. If you bought your Bitcoin in early 2017 or earlier and sold in 2018, you’re sitting on a tidy profit. As with other types of income, the IRS wants its share.
Fortunately, calculating your profit or loss and filing your cryptocurrency taxes isn’t difficult in many cases. Where the process can become tricky is if you have a lot of coin-to-coin trades or if you’ve made a lot of purchases with cryptocurrencies. If you’ve only invested in Bitcoin or other crypto coins through an exchange, the process is more straightforward.
Whether you’re invested in Bitcoin, Ethereum, or any other cryptocurrency, you’ll use the same general method to calculate your gains (or losses) and file your taxes in the same way regardless of the type of cryptocurrency. The IRS doesn’t distinguish between the thousands of cryptocurrencies in regard to how you report your gains; they are all the same to the IRS. However, each time you convert from one cryptocurrency to another, there is a taxable event. In that sole regard, there is a difference between types of cryptocurrencies.
Cryptocurrencies Are “Intangible Property”
The IRS does not consider cryptocurrencies to be currencies at all. Instead, cryptocurrencies are considered to be intangible property. In 2014, the IRS issued guidance indicating that while virtual currency operates like “real” currency and functions as a medium of exchange, it has no legal tender status in any jurisdiction. The IRS thus deems cryptocurrency to be a capital asset, treated as intangible personal property for tax purposes.
In the past, some cryptocurrency investors utilized what looked to be a loophole for like-kind exchanges. Those familiar with real estate investing and even homeowners may be aware that the IRS allows you to use the proceeds from the sale of a property to purchase another “like-kind” property without triggering a taxable event, even if you realized a gain on the first property.
The specific section of the Internal Revenue Code in question is Section 1031, which was amended under the Tax Cuts and Jobs Act of 2017, and now only applies to exchanges of real property, meaning real estate within the U.S., and not to exchanges of personal or intangible property. Going forward, cryptocurrencies are not eligible for like-kind exchange tax treatment.
What Defines A Taxable Event For Cryptocurrency?
In its simplest form, a taxable event for cryptocurrency occurs when the cryptocurrency changes hands. This means that, under the new IRS guidance, crypto-to-crypto exchanges are taxable events and if you have a capital gain, it must be reported as either a short-term capital gain if you held the cryptocurrency for less than one year or a long-term capital gain if you held the cryptocurrency for longer than a year. Under current IRS rules, an exchange from one type of cryptocurrency to another type of cryptocurrency is not a like-kind exchange, and therefore, any gains are taxable as income.
Of course, a sale of a cryptocurrency asset, in which you convert the asset to cash trading into another cryptocurrency, is also a taxable event.
Additionally, when you use cryptocurrency to make a purchase, this purchase transaction also creates a taxable event. Your “selling price” for the cryptocurrency is the value of the cryptocurrency in U.S. dollars at the time of the purchase.
The best way to understand how the IRS logic behind taxing crypto-to-crypto trades is to think of cryptocurrencies as property — like the IRS does — but there’s an extra step in the math. At each point in the transaction, there is a cost basis in U.S. dollars and a selling price in U.S. dollars. Traders may think of a trade as being Coin A traded for 10 of Coin B, for example. The IRS sees this transaction as a conversion to US dollars for Coin A and then a new investment in Coin B, creating a corresponding cost basis for Coin B, and thus, the transaction which trades Coin A for Coin B creates a taxable event.
Similarly, making a purchase with Bitcoin or any other cryptocurrency is considered to be a taxable event. You’ve converted the investment to U.S. dollars as far as the IRS is concerned and a profit or loss has taken place.
Short-Term And Long-Term Capital Gains Rates
For 2018, short-term capital gains continue to be taxed as regular income and would apply to cryptocurrency transactions in which you held the cryptocurrency for less than a year. Long-term capital gains tax rates are unchanged for 2018 and are taxed at rates of 0%, 15%, or 20%, depending on your tax bracket. Long-term capital gains would apply to cryptocurrency transactions in which you held the cryptocurrency for more than a year before selling the cryptocurrency, trading the cryptocurrency for another cryptocurrency, or making a purchase with the cryptocurrency.
Wallet-to-wallet transfers, whether within a year or after a year, are not taxable because the cryptocurrency did not change hands and at no point was converted back to U.S. dollars.
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Capital Loss Carryforward Limits
There is no limit on the amount of capital gains subject to tax. There is, however, a limit to how much you can carry forward as a loss in certain situations. In any given year, you can carry forward up to $3,000 in losses to offset current income. If you earned $50,000 in taxable income, a carryforward loss can potentially reduce your taxable income to $47,000.
However, if you have capital gains in the same year, your carryforward losses would first be applied to your capital gains and then any remaining losses can be applied to income, with a limit of $3,000. Losses in excess of what can be used to offset capital gains or reduce income can be carried forward again for use in future tax years until the loss has been used completely.
Finding Your Cost Basis
To determine if you have a profit or loss for each transaction you’ll need to know your cost basis. In plain English, your cost basis simply refers to how much you paid for a cryptocurrency in U.S. dollars when you acquired the cryptocurrency. Technically, your cost basis for any capital asset is your cost plus any improvements. In the case of cryptocurrencies, because you haven’t made any improvements, your cost basis is equal to your acquisition price. For example, if you purchased a bitcoin for $1,000, your cost basis is $1,000.
To take that example a step further, if you purchased Bitcoin for $1,000 and a year later you exchanged it for Ethereum, you’ll need to know the price of Bitcoin and Ethereum at the time of the trade. Let’s say bitcoin was a $2,000 at that time you traded your bitcoin for $2,000 of Ethereum. In this example, you would have a $1,000 in long-term capital gains on your bitcoin trade and a cost basis of $1,000 for the Ethereum you acquired.
Finding the relevant numbers will be less challenging if you’ve been using a large exchange like Coinbase/GDAX. In most cases, you should be able to download a report of your transactions on the exchange within a few clicks from the “my account” section.
If your cryptocurrency trades have been largely with one type of cryptocurrency on one or two exchanges, the math should be fairly easy, particularly if there haven’t been many trades. If, however, you’ve been trading cryptocurrencies frequently and in several marketplaces or making frequent purchases with cryptocurrency, you may have some research work ahead of you.
Some of the pricing information you’ll need might be available either in your cryptocurrency wallets or in reports made available through exchanges you’ve used but if you’ve had a lot of transactions you may want to consider using a service that aggregates historic pricing data and can help you assemble the numbers you’ll need to file your cryptocurrency taxes.
Cointracking.info is a popular option amongst cryptocurrency traders. The service tracks historical pricing for over 5,000 coins and can import data from exchanges or wallets, including digital or hardware wallets. Cointracking.info’s service is free for up to 200 trades and can provide you with the numbers you’ll need for tax reporting. Paid tiers can provide data for traders or investors with over 200 trades.
Blockfolio is another growing service, which serves as a bitcoin and cryptocurrency portfolio management app and provides pricing for over 3000 cryptocurrencies. Available as a mobile app for iOS and Android, Blockfolio promises to keep you up-to-date on cryptocurrency prices, the value of your portfolio, profit or loss, and as importantly, your cost basis.
Calculating and Reporting Losses or Gains
If you’ve only had one or two trades, all you need to do is subtract your cost basis from your selling price to determine the amount of your gain or loss. You’ll also need to determine if any gains are short-term or long-term gains.
If you’ve had multiple trades or multiple cryptocurrency purchases, this process can be a bit more time consuming simply due to the number of trades.
Capital losses are capital gains are reported on Schedule D of your 1040 tax form. Form 8949 serves as a detailed worksheet to report the sale of capital assets, like stocks or cryptocurrencies, and should be included with your return.
When to Use IRS Form 8949
Check out this video below to figure out when to use IRS Form 8949.
Recent guidance from the IRS makes the tax treatment of cryptocurrencies substantially similar to the tax treatment of stocks in a standard investment account.
Cryptocurrency tax reporting requirements may seem arduous but traders are encouraged to report their gains or losses accurately. Cryptocurrency trades may not be as private as some might think. Bitcoin’s blockchain, for example, contains a record of every bitcoin transaction in its history. The only thing keeping your transactions private is that the Bitcoin wallet owner isn’t public.
Fortunately, now there are some tools to help cryptocurrency traders find historical pricing. As cryptocurrencies continue to grow in popularity, traders can expect more tools and better reporting available through marketplaces.