Cryptocurrencies such as Bitcoin became extremely valuable and popular investments during 2017. This raised a multitude of questions about how cryptocurrency transactions should be taxed in the US. Thankfully, the IRS has offered some guidance and accountants have quickly come up to speed on the treatment of Bitcoin from a tax perspective.
Bitcoin as Income
Some employers choose to compensate their employees using Bitcoin rather than traditional currency. If this applies to you, the US dollar equivalent on the day the compensation was received must be reported on your W-2 form. This income is subject to withholding in the form of payroll and other taxes. Self-employed individuals who accept cryptocurrency in their trade or business must also convert to dollars and report on their tax return.
Bitcoin held as a Capital Asset
Just like stocks and bonds, cryptocurrencies can be bought and sold as their value fluctuates. If you sell Bitcoin for currency, exchange it for other cryptocurrency, or use it to buy something, you must report this as a gain or loss on your tax return. Any position held for less than one year is taxed as ordinary income (your individual marginal tax rate) while it is taxed as a capital gain (20% in 2018) if it is held for more than one year. As with other capital assets, losses can be deducted against other capital gains with net capital losses in excess of $3,000 carried forward to future years.
The gain can be calculated by taking the market value of property received less the cost basis (what you paid for it). If the trader receives cash, the market value is simply the amount of cash received. If they get a different cryptocurrency, the dollar equivalent of the coin should be reported as the market value of property received. If the coin is spent on goods or services, the market value received is just the estimated value of what was bought in US dollars.
There has been an on-going debate in the tax accounting profession about the treatment of coin-to-coin trades. Some have allowed their clients to treat these as like-kind exchanges, which are non-taxable. The tax basis is simply transferred to the new coin that is received, and the taxpayer does not pay tax until they sell the new coin. However, many disagree with this assessment, and say that coin-to-coin trades do not qualify as like-kind exchanges. They argue that coins are used for many different purposes, so an exchange of one person’s Bitcoin for another’s would not be considered like-kind. Additionally, some coin exchanges are not seen as qualified intermediaries, and therefore transactions on these exchanges cannot be treated as non-taxable exchanges.
As of now, the IRS has not issued a ruling on this subject. Fortunately, the Tax Cuts and Jobs Act passed in December limits like-kind exchanges to real property. Intangible property such as Bitcoin will always be taxed when disposed starting in 2018.
Some people choose to mine Bitcoin and other cryptocurrencies rather than buy them on exchanges. This raises all sorts of questions as to how mining should be treated for tax purposes. If the mining operation is clearly for the purpose of making profit, the IRS will consider it a business. Income is recognized when the coin is acquired or “mined”, not when it is sold or exchanged. Therefore, taxpayers should report the fair value of the amount of Bitcoin mined during the year under the income section of their Form 1099. All ordinary and necessary business expenses are deducted (electricity, depreciation on mining hardware and software, etc.) and self-employment tax will be paid on taxable income.
If mining is considered more of a hobby than a business, it has slightly different tax implications. Self-employment tax will not be paid, but there are far less allowable deductions than with businesses. Speak to an accountant to see if your Bitcoin mining would be considered a business or hobby.
Bitcoin is an extremely complicated form of property, and the tax law is still figuring out how to properly address its popularity. Anyone who buys, sells, mines, or is compensated in Bitcoin or other cryptocurrencies should conduct extensive research in order to properly figure out their tax consequences. Additionally, reach out to an accountant to learn exactly how to report cryptocurrency transactions on your tax return.