Do Tax Rules Apply to Bitcoin-Purchased Items?

If you’re a crypto enthusiast with Bitcoin, you may appreciate the ability to transfer money or buy things without a bank account. Privacy is one of the top advantages cited by people who love cryptocurrency, after all.

Although Bitcoin doesn’t require the use of banks, you still have to comply with the tax man when buying stuff. Learn what you should know about Bitcoin and taxes.

Bitcoin Investments Are Properties

The IRS (Internal Revenue Service) confirmed it views all cryptocurrencies as property. Plus, your tax forms must indicate Bitcoin purchases, which are subject to capital gains taxes. People who mistakenly believe the IRS treats cryptocurrencies the same way as cash are often taken aback when hearing about this distinction.

Any cryptocurrency investment that appreciates from acquisition to use is subject to capital gains taxes. Under IRS rules, two transactions occur when you buy something with Bitcoin. First, you give something to the merchant, which the IRS sees as a property sale. Then, you use the proceeds to buy something.

How much you pay in capital gains tax depends on how long you hold the cryptocurrency. For less than a year, the tax rate is the same as income tax. For longer than a year, the IRS bases it on your tax bracket, typically 15%.

Merchants charge sales tax at the time of your purchase. The capital gains tax is on top of that amount.

If you buy things with Bitcoin or other cryptocurrencies often, consider downloading an app that helps you track when you made a purchase and how much you spent. There are many free options, and you’ll be glad you have it when tax time arrives.

Not Clear-Cut for State Sales Tax

When you buy things with traditional currency, the tax rates vary by state. For example, five states don’t have sales tax. Unfortunately, most states have not ironed out special sales tax rules for cryptocurrencies.

Three states have made headway in crypto regulations. California, New Jersey and New York solidified laws on how merchants should handle sales tax on transactions, along with what customers should expect.

New Jersey authorities decided consumers are not subject to sales tax when they buy things with cryptocurrency. However, they must pay tax on the fair market value of the cryptocurrency itself.

The approach to calculating sales tax is almost the same in New York, except the consumer pays tax on the purchased goods. The method of determining market value of the cryptocurrency on the purchase date still applies, and the tax rate varies based on how much the person spends.

California, on the other hand, does things differently. It doesn’t require calculating fair market value at the time of a sale. Instead, the sales tax paid depends on the merchant’s selling price.

What Merchants Should Know

We’ve talked about Bitcoin and tax essentials buyers should know. However, it’s also useful to mention a couple of how tax rules affect merchants.

Are you a merchant who wants to accept bitcoin? Keep in mind the volatility means fair market value shifts a lot. In December of 2017, for example, Bitcoin was worth $13,860.14. One year later, it dropped to $3,689.56.

Does your state lack tax regulations on Bitcoin-purchased items? If so, keep in mind the fair market value at the time of purchase. Convert this value into U.S. dollars for income tax purposes. The process is even easier if you work with a merchant services provider accustomed to Bitcoin.

For example, some point-of-service terminals accept Bitcoin or fiat currencies. They often convert Bitcoin to fiat currency immediately to avoid the risk of a future downturn.

One of the advantages of merchants taking Bitcoin is alternative options for customers. Shoppers may view a store as forward-thinking if they offer cryptocurrency as an acceptable way to pay.

Do You Use Cryptocurrency? Don’t Avoid Bitcoin-Based Taxes

The IRS sent letters to thousands of U.S. taxpayers who they believe are dodging sales tax by not reporting cryptocurrency. Many believe they don’t need to pay taxes on Bitcoin investments or sales.

If you’re a crypto-lover, this explainer on Bitcoin taxes will steer you in the right direction. If you have doubts on how to report Bitcoin transactions — either as a consumer or merchant — seek professional tax help.

Knowing what to do instead of making assumptions will help avoid unforeseen consequences.