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With bitcoin, you can run afoul of the IRS in a few surprising ways, so it pays to learn the rules.
The big picture? Bitcoin and other cryptocurrencies that you buy, sell, mine or use to pay for things can be taxable. Also, if your employer or client pays you in bitcoin or other cryptocurrency, that money is taxable income. You report your transactions in U.S. dollars, which generally means converting the value of your cryptocurrency to dollars when you buy, sell, mine or use it.
Here’s more how using bitcoin can affect your taxes:
1. Bitcoin and other cryptocurrencies are property
In 2014, the IRS issued a notice declaring that for tax purposes, cryptocurrency is property, not currency. That may sound like a trivial distinction, but in this case it’s the basis for when the IRS decides whether individuals owe taxes.
These bitcoin tax consequences revolve around what the government agency calls a “realization event.” Here's how it boils down:
If you acquired a bitcoin (or part of one) from mining, that value is taxable immediately; no need to sell the currency to create a tax liability.
If you disposed of or used bitcoin by cashing it on an exchange or buying goods and services, you will owe taxes if the realized value (the sale price of bitcoin, for example) is greater than the price at which you acquired the bitcoin. You may have a capital gain that’s taxable at either short-term or long-term rates.
“Many people think that there’s no tax consequences when they sell an object — it’s for personal use and they’re expecting to lose money on it anyway, whether it be a car, an appliance or another piece of property,” says Brian R. Harris, a tax attorney at law firm Akerman LLP in Tampa, Florida. “Many people aren’t in the mind-set of holding tangible objects for investment and then recognizing gains when they ultimately sell them.”
“But if there’s been a gain from the bitcoin owner’s cost basis, there’s a tax liability,” he says.
» Find out what bitcoin is and how it works
2. Record-keeping is key
To make sure you stay on the right side of the rules, keep careful track of your cryptocurrency activity.
You'll need records of what the fair market value of your bitcoin was when you mined it or bought it, as well as records of its fair market value when you used it or sold it. That information will help you calculate your bitcoin taxes.
That information may not be easily available. If you were buying and selling stocks, for example, your broker would send you a Form 1099-B that would show the cost basis of your transaction. But with bitcoin you might not receive one — part of the reason many people have no idea they’re liable for bitcoin taxes. “It’s a potential way to run afoul of IRS laws,” Harris says. “You’re conditioned with the receipt of the 1099 to know that you have a taxable event and what that taxable gain is. You don’t always get that with bitcoin. So many people just aren’t being informed from the exchange in a manner that they’re used to.”
A Form 1099-K might be issued if you’re transacting more than $20,000 in payments and 200 transactions a year. But both conditions have to be met, and many people may not be using bitcoin 200 times in a year. Whether you cross these thresholds or not, however, you still owe tax on any gains.
While not paying taxes on your gains might be an honest mistake, don’t expect the IRS to take pity. The agency has already sued at least one cryptocurrency broker for the records of people who might not have reported their bitcoin gains.
3. If your bitcoin is stolen, tough
Being robbed is bad enough, and previously if you’d been swindled of your bitcoins, you might have been able to deduct it as a theft loss on your taxes. However, the new tax rules do away with the deduction for personal theft losses.
Another tax rule doesn’t look favorable for owners of digital currency, either. The IRS allows owners to trade many kinds of property for a similar kind of property without immediately incurring a tax liability — it’s called a like-kind exchange.
Before the tax law changes, bitcoin owners wanted to know whether they could engage in like-kind transactions with other cryptocurrencies. “The answer was unclear,” Harris says. “What was unclear was whether one crypto was like-kind to another. Now the new tax reform has limited like-kind exchanges to real property, not personal goods.”
4. There is a bit of relief for bitcoin taxes
Bitcoin taxes can be a bummer, but at least you can deduct capital losses on bitcoin, just as you would for losses on stocks or bonds. These losses can offset other capital gains on sales. When you’re done tallying your winners and losers, you can’t write off a loss of more than $3,000.
With drastic fluctuations in bitcoin’s price happening all the time, many bitcoin speculators will have losses. If you have losses on bitcoin or any other cryptocurrency, make sure you declare them on your tax return and see if you can reduce your tax liability.
Bitcoin taxes just for using bitcoin? It’s one more reason to be very careful with the cryptocurrency.