If you’ve bought any amount of Bitcoin a few months ago, the return has been awesome. With the flagship cryptocurrency hitting more than $35,000 per Bitcoin, many are flocking to “get in” before things go much higher. But at the strike of midnight between December 31st and New Years Day, the need to claim those gains starts to set in.
The potential problem? It’s three-fold:
- A relatively new asset (cryptocurrency)
- New tax laws (that many CPAs aren’t too familiar with)
- A rapidly growing group of investors who bought crypto and are rushing to figure out how to correctly file their taxes
This intro guide is meant to mitigate your uncertainty, help you understand how cryptocurrency impacts your taxes and move toward filing correctly.
How Do Taxes Work with Cryptocurrency?
Yes, Crypto is Taxed
There are many myths, when it comes to crypto. One of the most pervasive is that it’s untraceable and not taxable. Part of the confusion comes from the fact that it’s called “currency,” but the IRS doesn’t consider any crypto legal currency. But in an increasing number of cases, there are organizations who take coins and tokens in exchange for goods and services (aka transactions).
You will likely have a reporting obligation if you fit any of the following:
- You sold crypto in the tax year (particularly after making gains)
- Used one form of crypto to acquire another (and made gains)
- Used crypto to buy something in exchange, mined crypto or earned crypto, etc
- Gave enough currency away via charity
Note: If you purchased a cryptocurrency, like Bitcoin, and are holding it throughout the entire year (also known as HODL), it’s not going on your taxes (yet). Which leads to the next point of how crypto is taxed.
Coins Are Taxed as Property
Example: Someone purchases a home for $100,000 and it goes up in value to $120,000, the next year. Do they claim that $20,000 on their taxes? No.
Now, if this person were to live in the house for five years and sell it for $150,000. There would likely be some capital gains made. That income would indeed be taxed and need to go on that year’s return (the year of the sale).
Bitcoin is similar (although with a few exceptions). If you bought a Bitcoin at $6,000 and it’s worth over $35,000. And you decided to take a little profit before the end of 2020. Well. You’re going to have to claim that income.
Conversely, what if someone buys now (at the top)? Hoping for it to hit that $100k and above mark and it (for the sake of example) doesn’t. It heads back down into the $20k range. A loss is still required to go on your taxes.
Key point: Since crypto is treated as property, if you buy and hold, it doesn’t go on your taxes. However, any sale must be included on that year’s filing.
How You Obtained Your Crypto
Crypto isn’t considered currency, but property (as mentioned). That said, there are more and more organizations who accept certain coins and tokens as currency. You can also “mine” many of the coins, essentially “making” it. And since it has value, it’s taxed.
How (and if) you must claim it changes based on how it’s obtained/given. Here are the four most prominent ways:
- Buying on an Exchange (like Coinbase): You purchase it and it’s placed into a digital wallet. From there, you can send it, spend it, HODL it, etc..
- Mining: This is where you actually follow the mining procedures using computer components to “mine” for the coins.
- Donations/Gifts: Many causes, content creators and other individuals/organizations take donations in the form of some cryptocurrencies. This is an entirely different tax scenario.
- Exchange for Goods/Services: If you use crypto to purchase goods and services, you must pay fair market value on the coin itself.
Note: There are also additional instruments, such as IRAs and individual stocks based around the crypto market. By and large, these holdings are handled the same as similar investments.
Do You Really Have to Claim Cryptocurrency?
Failing to claim gains made from crypto can be as serious as skipping out on taxes entirely. A multitude of fines and penalties await anyone caught selling and profiting from coins and tokens without reporting it to the IRS. In fact, the IRS send thousands of letters to those who had sold cryptocurrency
Most don’t fail to file deliberately, but either don’t know the full extent of crypto and taxes or they’re intimidated by the process.
A Brief Word on “Hard Forks”
In an emerging asset class, like crypto, there are likely to be changes each tax season. The most recent update was in 2019. The main update here was in the event of a “hard fork” where a particular coin splits in two. A recent example is when Bitcoin “halved.” This is considered a hard fork.
You can find the full guidance from the IRS here, particularly questions 21-24.
Important: This IRS decision is both retroactive and includes those holding their crypto. So if you held a coin and it halved in that year, it must be claimed.
Prepare for Your Taxes Now
Cryptocurrency is an exciting market that began with individuals and has since made it into mainstream investment portfolios. And with the recent flagship (Bitcoin) bringing in historic highs, more excitement could be on the way.
If you’ve bought and sold coins this year, it has to go in your tax filing. Don’t shy away, but do your research and get in contact with a qualified accountant, like Founders. We understand crypto coin and token markets as well as the requirements laid out by the Internal Revenue Service.
Get in touch and let us know the basics about how you acquired your coin/token portfolio, which assets you sold and how you used them throughout this year. And if you’re still hodling, we hope your assets continue to grow.