Recently, the IRS started sending letters to cryptocurrency traders in the USA, asking them to pay taxes. As a result, the proper calculation and correct reporting of taxes on Bitcoin gains has become important for crypto traders too. This has raised questions about the rules of cryptocurrency taxation and how to calculate tax rates on Bitcoin trading, mining and purchasing. This article covers the fundamentals of Bitcoin taxes and how to report them to the IRS.
Bitcoin taxation basics
According to the IRS, Bitcoin and other cryptocurrencies are classified as property. So all the general tax principles applicable to property transactions apply to transactions using virtual currency as well.
First of all you should understand if you even fall under the tax regulations and if you have to report to the IRS. The IRS uses the term taxable event – a situation when you have to report on your transaction activity:
- Trading cryptocurrency to fiat currencies like USD
- Trading cryptocurrency to another cryptocurrency
- Receiving cryptocurrency as a payment for goods and services
- Cryptocurrency mining
What is not a taxable event:
- Buying cryptocurrency
- Wallet to wallet transaction
- Sending Bitcoin as a gift
- Holding BTC
Calculate the capital gain/loss
Ok, now you need to calculate your Cost Basis, which is how much money you spent on purchasing the property. For cryptocurrencies it is the purchase price plus brokerage, transaction and other fees. The formula of Cost Basis is simple:
For purchase: Purchase Price of Crypto + Other fees = Cost Basis
For crypto-to-crypto trading: Purchase Price of Crypto + Other fees = Cost Basis
For mining: Electricity Expenditures = Cost Basis
Let’s say you bought 0.5 Bitcoins in December 2018 for $1600. You paid a brokerage fee of 8%. The results are the following: $1600 + $1600 * 8% = $1728 – this is your Cost Basis.
Then you sell Bitcoins and need to calculate your gain or loss. Just subtract your Cost Basis from Fair Market Value. For purchase and crypto-to-crypto trading, Fair Market Value is the sale price of Bitcoin in US dollars. For mining, the Fair Market Value is the price of coins when you have successfully mined a digital currency.
Fair Market Value - Cost Basis = Capital Gain/Loss
You were lucky and traded all your funds when BTC pumped to $9000. That means. you sold 0.5 Bitcoin for $4500: $4500 - $1600 = $2900. $2900 is the amount you need to pay taxes for.
Learn your Bitcoin tax rate
One more step, you have to calculate how long you owned crypto before selling it. Your Bitcoin tax rate depends on this. There are short term and long term gains:
- If you hold BTC for one year or less – you got short-term gains
- If you hold BTC for more than one year – you got long-term gains
The taxes depend on your annual income, your status and how long you held your coins.
Here’s a table of tax rates for short term gains:
If you are mining Bitcoins as a self-employed person your income is subject to the self-employment tax. The self-employment tax is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance). More information can be found here, on Chapter 10 of Publication 334, Tax Guide for Small Business and Publication 535, Business Expenses.
How to calculate Bitcoin taxes?
Ok, you’ve got Cost Basis, calculated your Capital Loss, know your annual income and how long you have held Bitcoins. Let’s take a look at an example:
- You are a single person who makes up to $25,000 per year
- You bought BTC in December 2018 and sold it in January 2019 resulting in $2900 gains
- You’ve held your funds only for 2 months – you’ve made short term gains
- The tax rate for you is 12%
- $2900 * 12% = $348 – is how much you have to pay in taxes
How to report to the IRS
To report to IRS you need two forms: the Schedule D and the 8949. In the Schedule D you report your capital gains for any type of property like cars, stocks and cryptocurrencies.
The 8949 is used to detail each Bitcoin trade and the gains you received on each trade. You should sum up the gains at the end of the 8949 and then transfer this sum into the Schedule D.
But what if I’ve had losses
If you’ve sold your crypto at a loss, you can claim it as a deduction. $3000 is the maximum amount you can deduct each year. How does it work? Let’s take a look at an example:
Two months ago you sold 0.5 BTC for a $500 profit. Yesterday, you sold 1 BTC for a $50 loss. Now you can pay taxes on only $450.
If you’ve reached the $3000 cap, you could use the extra amount to offset taxable gains the next year.
Please note that this article is for informative purpose and contains general information of Tax rules. We recommend you to read an official IRS guidance and confer with your tax consultant.