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It’s an exciting (and frustrating) time for Bitcoin and cryptocurrencies. In late 2017, numerous coins experienced soaring growth in terms of price-per-coin and market cap, and thousands of speculators hopped aboard the bandwagon to make a quick buck.
And even though many of these coins experienced a correction in January 2018, the price still sits higher than it was last September and it’s possible you’ve made a hefty profit. What do you do with that money? Is cryptocurrency taxed? Here’s everything you need to know.
This article is written for the 2017 tax year for United States residents and may not apply to other countries. This article is NOT meant to be a substitute for legal tax advice and guidance. If you hold cryptocurrencies, we highly recommend consulting a certified tax professional.
Paying Taxes on Mined Cryptocurrency Coins
Suppose you built yourself an energy-efficient rig for mining Ethereum, then ran it for a while and actually walked away with a few coins in your pocket. Are these taxed? Yes!
Every time you successfully mine a bit of cryptocurrency, this counts as a taxable event in the eyes of the IRS, and these taxable events are classified as ordinary income. You must track every single day on which you had a successful mining event, then determine the fair market value of the cryptocurrencies you mined on those days.
If mining is a hobby, this amount is reported as “Other Income” on the Schedule A tax form. If mining is a business, this amount is reported as “Other Income” on the Schedule C tax form. Learn more about hobbies or businesses according to the IRS.
How the IRS Views Cryptocurrency Trading
The IRS considers cryptocurrencies as investments [PDF]. Many of the rules and guidelines that apply to stocks in taxable brokerage accounts also apply to cryptocurrencies, though there are a few nuanced deviations (which we’ll cover below).
Because they’re counted as investments, cryptocurrencies are reported using the Schedule D tax form, which you can download on the IRS website. If you use tax software to file taxes, Schedule D may only be available in more expensive versions.
When trading, you DO NOT need to report cryptocurrencies until you sell your holdings. If you bought a bunch of Bitcoins in 2017 and haven’t done anything since then, you can relax for now. If you sell only a portion of your holdings, you only need to pay taxes on that portion.
Note: If you trade a cryptocurrency for something that isn’t money (e.g. a different cryptocurrency), the IRS still views that as if you first sold the cryptocurrency and then bought the item with the proceeds. This means you DO have to pay taxes on the amount of cryptocurrency that was traded! Learn more about bartering income.
Paying Taxes on Traded Cryptocurrency Coins
There are two important bits of information you need to track when trading cryptocurrencies: the basis (i.e. the price at which you bought in) and the proceeds (i.e. the price at which you cashed out). You should also know when you bought in and cashed out.
Every time to sell cryptocurrency holdings, you need to report that transaction. However, you can combine all of those transactions at the end of the year to determine whether you had a net gain or net loss, then use this figure to determine the tax impact.
If you have a net gain, then you will owe taxes on the amount you gained. If you have a net loss, then the amount you lost will decrease your overall tax liability, meaning you’ll owe less money come tax time.
Short-Term Gains vs. Long-Term Gains
The IRS recognizes two types of capital gains/losses.
Short-term gains occur when the time between buying and selling is one year or less, and they are taxed at your marginal income tax rate. If you have multiple short-term gains (or losses), then they are netted together.
Long-term gains occur when the time between buying and selling is at least one year and one day or longer, and they are taxed at capital gains tax rates. If you have multiple long-term gains (or losses) in a given year, then they are netted together.
If your marginal income tax rate is either 10% or 15%, then long-term gains are taxed at 0%; if your marginal income tax rate is 25% to 35%, then long-term gains are taxed at 15%; otherwise, taxed at 20%. Learn more about capital gains and losses.
Do You Really Have to Do All of This?
If you want to be a law-abiding citizen in good standing, and if you want to avoid potential trouble with the IRS later down the road, then yes, you must pay taxes on cryptocurrencies.
What if you bought your coins months ago and don’t have the right records to establish basis or report your transactions? You still have to do the best you can. It’s better to put in the effort now to research market values, make sensible estimates, and ensure your taxes are as accurate as possible instead of facing the wrath of the IRS years from now.
If you’re ever audited, you’ll need those records to show the IRS you exercised due diligence.
Lastly, some people may tell you that paying taxes on cryptocurrencies is unnecessary because it’s “impossible” for the IRS to trace transactions back to you and hold you accountable for any gains you may have realized — the same arguments used by some who work jobs that pay cash under the table. Whether or not it’s feasibly traceable, paying taxes is the lawful and ethical thing to do. Keep in mind that tax avoidance is a felony offense.
Expanding Your Knowledge of Cryptocurrencies
One topic we didn’t cover is what to do when your cryptocurrency is hard forked. There’s a lot of murkiness surrounding the topic and nobody is quite sure what to do as of this writing, so we definitely recommend seeking counsel from a tax professional if your holdings were forked.
That said, there’s more to the world of cryptocurrencies than buying and selling Bitcoins. You may want to look into Ethereum (differences between Bitcoin and Ethereum), Ripple, Litecoin, NEO, IOTA, and more. Also look into cryptocurrency ICOs, but be aware of common cryptocurrency scams.
One thing to keep in mind is that cryptocurrencies may not be as secure as you’ve been led to believe. And if you’re going to involve some serious money, then you should always keep your cryptocurrencies in cold wallets.
How did you fare with cryptocurrencies this year? Do you think the trends will continue or will this next year be the end of it? Let us know in the comments!