The IRS Is Cracking Down on Investors… Here’s What You Need to Know About Paying Bitcoin and Crypto Taxes
By Trakx on Altcoin Academy
As 2019 comes to a close, the 2020 tax season is upon us, which means that it is time once again for traders, investors, and business owners to calculate their capital gains and report their income and profits to the government.
One big mistake that many crypto traders have made in the past was reporting their earnings incorrectly or failing to report at all. Although there is a common misconception that Bitcoin is anonymous, the recent crackdown that took place earlier this year, in which the IRS sent letters to over 10,000 people asking them to pay back taxes, demonstrates the need to file properly. Even entities outside of the U.S., such as the U.K.’s HMRC, are taking further steps to ensure tax compliance.
That said, recent changes to cryptocurrency tax guidelines and the complexity of the digital assets themselves can make it hard for those in possession of crypto to understand where to begin in the filing process. Fortunately, crypto taxes are easy to understand once they are explained.
If you have engaged in any crypto transactions over the past year, here’s what you need to know about paying Bitcoin and crypto taxes.
Crypto As a Tradeable Asset
When crypto is purchased and exchanged at a later date, cryptocurrency is taxed as a tradeable asset. For example, let’s imagine that you purchased one Bitcoin in January of this year and sold it when the price spiked up to $12,000 in May. As a result of your sale, you would have to report your profits as capital gains for the sale of that asset and pay the resulting tax. (However, you may also claim losses if the value of your asset’s value depreciated over that time instead.)
Along with trade transactions, other transactions, such as making purchases with your crypto, are considered taxable events as well. Continuing with the above example, let’s imagine that you spent $2,500 of your Bitcoin on your rent. You would need to sit down and calculate exactly how much that portion of your asset has gained since its initial purchase. Of course, this brings up the question of how exactly to calculate these gains. We will dive deeper into this topic after the next section.
Put simply, any time you spend your asset, exchange your crypto for a similar asset or a fiat currency, or otherwise engage in a transaction that involves receiving something in return for your crypto, you need to report any capital gains or losses.
Crypto As Income
While crypto is used by many as a tradeable asset, there are also those who make a living through trading crypto or through accepting crypto through a business or as part of their paycheck. If crypto is earned, it becomes taxable not only as an asset when it is traded but as income as well. The type of work that you do in return for crypto will dictate how you will need to file when you report this income.
What’s truly important to know, however, is that any form of income is taxable. In the IRS’s new guidelines, they touch upon the topic of forks as an example and the resulting cryptocurrencies that you may obtain through a hard fork. If you receive any amount of cryptocurrency, whether you asked for it or not, you are responsible for reporting it as income. As always, there are some exemptions, such as gifts, which you will only need to report when you sell or trade it at a later date.
How Does Crypto Tax Filing Work?
Reporting fiat currency is simple as there are no price fluctuations that complicate your filing efforts. Cryptocurrency, on the other hand, is always changing, which makes it more difficult to determine what you owe and how you need to report it.
In general, there are four main accounting methods that people turn to in order to report their crypto profits: first in first out (FIFO), last in first out (LIFO), average cost, and specific identification. Simplified, they look like this:
- FIFO- The crypto that you spend or trade is taken from your first purchase. If you spend one Bitcoin and you own two Bitcoin, you calculate your gains or losses based on the first Bitcoin that you acquired.
- LIFO- Using this accounting method, traders do the opposite of the above, calculating gains and losses by drawing from their most recent purchases first.
- Average Cost- One of the easier accounting methods, the average cost is calculated by determining the amount of holdings you have sold and pulling from the overall price of your assets. This method isn’t as commonly seen as the other three, however.
- Specific Identification- If you can show the IRS proof of specific transactions stored in different places, you can choose which asset you want to calculate your gains or losses on. For example, if you have one Bitcoin stored in address A and one in address B and you spend one Bitcoin, you can choose which asset you sold as long as you can provide documentation of the purchase of said asset.
As always, it is vital that you do your research, consult professionals, and fully understand your responsibilities before you begin trying to report your income and capital gains. While the above gives you an overview of what you can expect to come across as you prepare your crypto taxes, it is ultimately up to you to make sure that you are compliant and up-to-date with local tax laws.
If you have sold any crypto over this past year, use the above as a starting point for learning more about how to file cryptocurrency taxes before the deadline arrives.