Cryptocurrencies like bitcoin and ethereum have grown in popularity over the past five years. This growth has drawn attention from governments around the world, and in the US the IRS recently announced that the taxation of cryptocurrency is one of its top 5 priorities for the year. This has a lot of traders and tax professionals asking the question — How is cryptocurrency taxed?
How Is Cryptocurrency Taxed?
As stated in the official guidance put out by the IRS in 2014, cryptocurrency should be treated as property for tax purposes, not as currency.
This means that cryptocurrency is subject to capital gains and losses rules similar to other forms of property like stocks, bonds, real estate, and gold. In other words, you need to report your gains and losses for all of your cryptocurrency transactions and investments on your taxes.
Let’s say you buy 0.5 bitcoin for $3,000 in April 2019.
If you simply buy and hold this cryptocurrency, you do not owe any taxes until you realize a taxable event (like the sale or trade of your crypto).
Now let’s say three months go by, and you sell this 0.5 bitcoin for $5,000.
In this scenario, you have incurred a $2,000 capital gain on the sale of your bitcoin.
This sale triggers a taxable event, and you will need to report this gain on form 8949 of your tax return.
What about Crypto-to-Crypto trades?
When you trade one cryptocurrency for another, this also triggers a taxable event that you will need to report on your taxes. In this scenario, the capital gain/ loss calculation is not as easy because your trades are not quoted in US dollars or other FIAT currency.
Let’s review the capital gain/ loss equation:
Fair Market Value — Cost Basis = Capital Gain / Capital Loss
What is Cost Basis?
Cost Basis is the original value of an asset for tax purposes. In the world of crypto, your cost basis is essentially how much it cost you to acquire the coin.
What is Fair Market Value?
In the simplest sense, fair market value is just how much an asset would sell for on the open market. Again with cryptocurrency, this fair market value is how much the coin was worth in terms of US dollars at the time of the sale.
So now let’s say you traded 0.5 bitcoin for 20 Ether instead of selling it for dollars. In this case, you still trigger a taxable event that needs to be reported; however, it’s a bit harder to calculate your fair market value because you did not sell for dollars.
So in this case, the fair market value is whatever 0.5 bitcoin or 20 ETH was worth at the time of the transaction.
Your cost basis was $3,000, and this is what you paid for the 0.5 bitcoin initially.
Your fair market value is $5,000 which is what 0.5 bitcoin or 20 Ether was worth at the time of the trade.
Your capital gain is $2,000, and you will owe a tax on a percentage of this gain.
If you have a high number of cryptocurrency trades, you can see that these calculations can become very difficult to do by hand. Thankfully there is cryptocurrency tax software that is built to automate the entire crypto tax reporting process. Simply import your trades and generate your tax reports.
(Editor’s Note: The Author of this article is the Co-Founder of Crypto Trader Tax)
What if I Lost Money Trading Cryptocurrencies?
Many traders lose money when trading crypto. These losses are still required to be reported on form 8949, and they will actually reduce your taxable income and save you money on your tax bill.
For tax purposes, mined cryptocurrency is treated as regular income at the time it is mined. You should use the fair market value of the cryptocurrency at the time it was mined to determine the amount of income received.
Crypto Tax Software
If you are looking for a quick way to generate your necessary crypto tax reports, you can use CryptoTrader.Tax. Simply import all of your historical data into the application and create your reports!
- This post is for informational purposes only and should not be construed as tax or investment advice. Please speak to your own tax expert, CPA or tax attorney on how you should treat taxation of digital currencies.