Investing in Cryptocurrency? Here’s How to Approach Tax Season
For the tech-savvy, cryptocurrencies like Bitcoin are rapidly becoming a popular form of investing. As more and more banks, countries, business, and individuals start adapting to the new reality of digital money, the value of cryptocurrency keeps going up. Mining and trading for Bitcoin and other cryptocurrencies can be a great way to invest and grow your money if you know what you’re doing. However, one thing that many cryptocurrency investors don’t take into account is how cryptocurrency trading affects their income taxes.
ALSO READ: Is Bitcoin An Asset Or A Currency?
It’s easy to think of cryptocurrency as different and separate from the “real” money you report on your tax returns, but since the whole point of cryptocurrency is to provide a way to make and exchange real money, you can’t overlook the tax implications. If you’ve gained (or lost) any real money as a result of your cryptocurrency investments, the IRS wants to know about it.
Cryptocurrency can feel like a new and somewhat unregulated financial frontier, but you don’t want to mess with the IRS. Following the guidelines for reporting cryptocurrency trades on your federal tax filing will help ensure your investments stay clean, legal, and worry-free.
What is Cryptocurrency?
It helps to understand exactly what we’re referring to when we talk about cryptocurrency. At the most basic level, cryptocurrency is a digital or virtual form of currency that is secured and validated using cryptographic technology. Many popular cryptocurrencies, like Bitcoin, use something called a blockchain to authenticate transactions. A blockchain is an online, public ledger that records every transaction having to do with a particular cryptocurrency.
New units of cryptocurrency are “mined” by computers, which perform complex calculations that are recorded in the blockchain. Cryptocurrency units are not issued by any bank, government, or other central authority.
Some individuals and businesses will accept cryptocurrency as a direct form of payment for their products or services. However, people primarily use cryptocurrencies as an investment vehicle, by buying or mining cryptocurrency units and then selling them to other enthusiasts and investors when the exchange rates are favorable.
Cryptocurrency and Income Taxes
According to the Internal Revenue Service, any money you make from exchanging cryptocurrencies is taxable by law. They have issued guidelines on how to report cryptocurrency holdings, and the bottom line is that cryptocurrency is treated like a capital asset, as far as your taxes are concerned. That means you report financial gains or losses related to cryptocurrencies as you would with stocks, bonds, real estate, and other property—not like income.
Buying cryptocurrency is not, in itself, anything you need to report to the IRS. You only need to report when you have a taxable event and realize some gains or losses. For instance, if you bought $1,000 worth of Bitcoin and sold it for $1,500, you would have to report your gain of $500, just like if you made money from buying and selling stocks.
If you sell at a loss, you want to report that, too. You can claim up to $3,000 (or $1,500, if you’re married and filing separately) in losses, which reduces your taxable income.
Keeping Good Records is Key
It’s very important to keep accurate records of your cryptocurrency purchases and sales. The length of time you hold on to a capital asset affects how it is taxed. If you hold it for more than a year before a taxable event occurs, it’s a long-term gain or loss. Otherwise, the asset is a short-term gain or loss. Short-term gains are taxed as ordinary income, but different rates apply to long-term gains. If you have multiple transactions and taxable events to account for, it’s probably a good idea to consult with a tax professional.
When keeping records, you want to take note of when you purchased the cryptocurrency, how much you paid for it, when you sold it, and how much you sold it for. It’s very unlikely that you’ll get a 1099 form from any cryptocurrency exchange site you’re using, so it’s your responsibility to record and report your gains and losses.
For tax reporting purposes, it doesn’t matter how much the value of your cryptocurrency fluctuates while you’re holding it. Only the price when you buy it and when you sell it matters. However, spending cryptocurrency like regular money can be a taxable event, when it causes you to realize losses or gains.
Can You Get Away with Not Reporting?
You may be wondering, how will the IRS even know if you’ve been buying or selling cryptocurrency? Is there really a downside to just not reporting it at all? The IRS is actually paying closer attention to cryptocurrencies these days, and they’re only going to get smarter when it comes to identifying and auditing taxpayers who have unreported cryptocurrency profits. You can be liable for significant penalties, and even criminal charges, if the IRS finds out you haven’t been truthfully and accurately reporting on your tax returns.
Rather than putting yourself in a compromising position, keep good records and report any money you make or lose from your cryptocurrency investments. If you aren’t sure how to report it correctly or how to handle capital gains or losses when you file, consult tax professionals to make sure your taxes are expertly filed, and to ensure you can continue “business as usual” without worrying.