Bitcoin is a form of virtual currency that lives and moves through a cryptographic encryption system. This complicated system secures bitcoin transfers. It also virtually stores the currency, hence the term cryptocurrency. You can use bitcoin to buy goods and services.
Bitcoin appears listed on exchanges along with world currencies like the US dollar and the euro. At first, people were attracted to bitcoin because it wasn’t regulated. You could use it to avoid paying taxes.
Not so anymore. The US Internal Revenue Service (IRS) and its global counterparts are regulating cryptocurrency tax.
Cryptocurrency Tax as Capital Gains
The IRS and its counterpart agencies view bitcoin as an asset rather than currency. It is not issued by a central bank the way regular currency is.
You have to report any and all bitcoin transactions to the IRS. So you should keep a record of all bitcoin transactions whether you were the buyer or the seller.
Since the IRS doesn’t recognize cryptocurrency as currency, paying for goods or services with bitcoin is essentially bartering.
Even if you use bitcoin for simple transactions, you will still pay a capital gains tax. You will pay either long-term capital gains or short-term. Which type you pay simply depends on how long you had the currency in your possession.
Transactions That Incur Cryptocurrency Tax
Here are some transactions that will lead to a cryptocurrency tax:
- Selling bitcoin to a third party that you have mined yourself.
- Selling bitcoin that you bought from someone to a third party.
- Using bitcoin you have mined to buy goods or services.
- Using bitcoin you bought from someone to buy goods or services.
Instances one and three involve mining your own bitcoin and then selling it for cash or goods and services. The IRS taxes the value you received from the transaction as personal income after deducting the expenses of mining the bitcoin. The IRS treats instances two and four like investments in an asset. Let’s say you bought the bitcoin for $200 each. You gave up one bitcoin for $300 (or that value in goods).
So, you earned $100 profit. You will incur a capital gains tax on $100 earned. The holding period is long-term if you held it for more than one year. Less than one year is short-term.
Tax Rates on Capital Gains
Long-term capital gains tax rates are 0% if you are in the 10%-15% ordinary income tax rate bracket. If you are in the 25%-35% tax bracket, your rates are 15%. If you are in the 39.6% bracket, rates are 20%.
You will pay lower than the 10%-15% rate if you held the bitcoin longer than one year. However, the IRS limits the tax deductions you can claim on long-term capital losses. You can claim only the total capital gains you made in the year plus up to $3000 of your ordinary income.
Reporting Cryptocurrency Transactions
To report your transactions, use IRS Form 8949 to add them all up. Then report it on Schedule D, along with any other capital gains.
If you have additional questions about filing your taxes, please contact us.