We're coming up to the tax filing deadline of April 15th.
If you haven't yet started, just not clicked Submit or not put your return in the mail, here are 10 things individuals need to remember when including Bitcoins or other digital currencies in your tax return.
1. Gains are realized even if you never withdrew USD
When you are trading Bitcoins or digital currencies on an exchange, each sell order must be included in your capital gains calculations, even if you never withdrew the dollars to your own bank account.
If you received USD, another foreign currency, or even another digital currency, you have potential capital gains/losses.
2. Long-term gains have discounted tax rates
If you sell or spend a Bitcoin that you can show you owned for more than a year, it is classed as long-term and any gains made will have favorable tax rates. The rate depends on your other income, but will wither be a flat 15% or 0%. There is a 20% rate for high income earners ($406,751 or more).
3. Losses can be offset against income to reduce taxes
Short-term capital gains and losses are combined, then long-term gains and losses, and finally these totals are combined into a net gain or loss. If you have a net loss you can use it to deduct up to $3,000 taxable income per year, saving yourself $750 in taxes (25% tax rate).
4. To FIFO or not to FIFO
When you calculate capital gains the default and preferred method by the IRS is to use First-In-First-Out. This literally means that when you sell a Bitcoin you take the price of the first one you owned as the cost basis in order to calculate gains.
There is something else called specific identification, where you choose which coin you want to sell. Some examples of this are Last-In-First-Out or Closest-First-Out. You might use these if you want to maximize long-term gains, maximize losses or even get close to zero gain.
However, the IRS hasn't explicitly clarified which method you should use and so this is something you should talk through with your tax professional.
5. Mining is income
The IRS treats mined coins as income on the day they are received. The value of the coin is its fair price or market value. You can use any rate table, for example bitcoinaverage.com, of your choice as long as it is consistently used.
While Bitcoin has established markets, some newer mined coins might not. How do you determine the market price of a new coin? This is another question yet to be clarified by the IRS and discussed with your tax professional. You could treat a coin without a market as having zero value, or a coin with only a BTC market as having the relative price of BTC as its value.
6. Being paid in Bitcoins is like receiving dollars
If you are paid in Bitcoins, as far as the IRS is concerned, you were paid in dollars. If you were paid by an employer, it is likely the figures have already been included in your W2 and there is nothing else you need to do.
But if you received those coins, for example, from a consulting job, then you need to report the fair value of the coins as your income. Say you did some work that you would normally have been paid $1,000, but you received Bitcoins, then you report $1,000 as income in your taxes. If you just received some BTC with no equivalent USD value, then you must calculate the fair or market price of those Bitcoins when you received them, and that is your income.
7. Received Tips/Gifts aren't taxable
If you were tipped, as long as it was not for any provided product or service (i.e. you didn't earn it), then it is gift and not due taxes.
If you were given the cost basis along with those tips, you can use this information to reduce any gains when you come to sell them. However, you cannot take losses from the basis of these coins, but instead have to use the market value.
8. Spending Bitcoins is like selling Bitcoins
For tax purposes, spending Bitcoins or any digital currency, is treated as if you had just sold them. If you bought a $100 gift card with Bitcoins, you effectively sold those Bitcoins for $100, and any potential capital gains must be calculated.
There is no threshold for capital gains. Everything is supposed to be included. However, typically these figures are rounded on tax forms, so any gains less than $0.50 are ignored.
9. Charitable donations can be a tax bonus
Making charitable donations with Bitcoin has a tax advantage when they are long-term. When you donate long-term Bitcoins (that you have owned for more than a year) to a registered charity, you get to write off the full market value of those coins as charitable deductions.
Short-term Bitcoin charitible donations can only deduct their original cost basis and not their market value.
10. The burden is on you to keep records
If you were ever audited and you need to account for any capital gains, especially long-term where the tax rate is reduced, you may have to show documentation to prove your position. The burden is always on you to keep documentation and perform recordkeeping.
If an exchange you were using suddenly disappeared and you can no longer obtain your records, you might having difficulty proving any gains from any trades. You could, for example, find those long-term gains get changed to short-term.
- Keep records of all your bitcoin activity.
- Periodically download your trading history from any exchanges you use.
- Export transaction logs from any wallets you have.
- Ensure you have records for each time you spend any Bitcoins.
If you need more information, check out our series on Filing your Bitcoin Taxes.
BitcoinTaxes is the best tool for calculating capital gains taxes and income for Bitcoin and all digital currencies. Click here to get started.