Crypto and Taxes — The Basics Part 2
This is Part 2 of 3 on how to file your cryptocurrency taxes.
Part 1 went over the basics of creating a capital gains/loss report. We will touch on things like cost basis, 1099B, etc.
Part 2 will go into “How do I know if I need to pay taxes?” We will go over use cases such as buying altcoins, mining, donating, etc.
Part 3 will go into some of the tools / services out there to help you calculate the reports.
Disclaimer: This isn’t tax advice, nor does it replace hiring a CPA. This information is based on personal experience, filing my own taxes, and talking with friends/CPAs on how they filed theirs.
So what do you need to do? You may be asking, do I need to pay taxes on my cryptocurrencies? The answer is Yes (if you triggered a taxable event).
This post is for you if you did any of the following (and you are a U.S. citizen):
- Buying cryptocurrencies (i.e. Ripple, NEO, Stellar, Ark, etc) on an exchange with another cryptocurrency (common ones may be Bitcoin, Ethereum, Dogecoin)
- Sold any cryptocurrency to USD/fiat
- Purchased something with cryptocurrency
- Mined cryptocurrency
- Received cryptocurrency as payment
- Selling/receiving forked coins
- Gifting cryptocurrency
- Donating cryptocurrency
- Other “Gotchas”
Purchasing a cryptocurrency with another cryptocurrency
This is the most common scenario and the community believes this is a taxable event.
Why? Let’s say you bought 1 Bitcoin at 10,000. The next day that 1 Bitcoin is worth 12,000. Now let’s say you traded Bitcoin for Ripple. You are now able to buy $2,000 more Ripple the second day than the first day. In reality, you didn’t “trade” the Bitcoin. You sold it at $12,000 and then purchased $12,000 worth of Ripple. In the IRS’s eyes that means you need to pay capital gains on the the $2,000.
Note: There are some people that state this type of trade is similar to the “like-exchange” that occurs most commonly in real estate. In Dec 2017, Trump changed the 1031 Exchange to be more explicit to only real estate (before it stated intangible property as well).
Some people view this clarity as a potential argument to count cryptocurrencies part of the as like-exchange clause before the change. No doubt, some people will fill out the forms for their cryptocurrency, but it gets complicated. If you feel you want to go down this route, I highly recommend to use a CPA.
Selling cryptocurrency to USD on an exchange
This is very similar to selling a stock on an exchange. If you used Coinbase or Gemini in 2017 to sell your cryptocurrency to USD then that is a taxable event. In Part 1, we explain what information you need to record.
Purchasing a commodity with cryptocurrency
More and more stores are accepting cryptocurrency. Let’s say you went to your favorite laptop store and purchased a laptop for 0.1 BTC. You just triggered a taxable event. So what now? You need to calculate the fair market value of the laptop (most of the time its just the cost of the laptop in USD).
So, let’s say you bought that 0.1 BTC for $500 dollars. When you purchased the the laptop that 0.1 BTC was worth $1000 dollars. You have to report capital gains on that BTC. The cost basis was $500. The proceeds was $1000. The capital gains was $500 (which will then be taxed).
Note: You can remove the transaction fee from the proceeds (if you had to pay any)
Mining cryptocurrency
First off, thanks for helping the network :)! Unfortunately, taxes are not fun with mining. When you mine and receive cryptocurrency, that counts as Income. Once you receive that cryptocurrency, you need to record the price at that time (that becomes your cost basis). When you sell that cryptocurrency, you need to calculate the gains you made on that cryptocurrency (from the time you mined it til the time you sold it).
The “tricky” part is how you report it as “other income”.
If you are consistently mining, it would probably fall under self-employment (that comes with its own type of taxes and deductions). If you fall under self-employment, you may be able to deduct things like electricity, mining equipment, etc.
If you aren’t consistently mining, then it could be placed as “other income” on your 1040 (you can’t deduct expenses on this route).
Received cryptocurrency as payment
This is similar to mining (i.e. income and calculating your cost basis).
Note: I have yet to see a 1099-Misc with Bitcoin on it because the form isn’t flexible to support it.
Selling/Receiving forked coins
If you received “free” Bitcoin Cash, Ethereum or any other cryptocurrency from a “fork” then you also triggered a taxable event.
The community believes there are 3 options you can choose from:
Option 1: The first method is to pick up ordinary income at the price of the forked currency when you took possession of that forked currency.
Option 2: The second one is you allocate basis based on either fair market value or the number of forked currency that you received. In this case, no income is deemed to be received at this time.
Option 3: The third is to pick up no income and allocate no basis
Option 3 seems to be the most popular one in the cryptocurrency tools I have used (probably because it is the easiest to report). When you sell it, you count it as capital gains with a cost basis of 0.
Gifting cryptocurrency
Yes, you can gift cryptocurrency to a friend or family member. Just make sure you are within the yearly (~14k) / lifetime limits. You should provide your friend with the cost basis (aka what you paid for it), so he/she can keep it for his records in case he/she sells it. He/she will need to pay capital gains on when he/she sells it. You do not need to pay any taxes on it (but be careful most tools don’t do a good job of reporting this).
Donating cryptocurrency
Yes, you can donate cryptocurrency to 501(3)c. It is very similar to donating stocks. Unfortunately, it is a little complicated and you should do research on the best way to donate and receive a deduction. Pineapple Fund did a great job donating a ton of money to charities!
Other Gotchas
- FBAR requirements. If you had more than $10,000 on a foreign cryptocurrency exchange (i.e. Binance, Bitfinex, Bitstamp, etc) than you need to report that.
2. Airdropped tokens. If you received “free” tokens from ICOs and giveaways, you should follow the same rule you applied to forked coins.
I can’t wait for the day that the IRS simplifies this process. Even though it is a tedious process right now, with some tools and a little bit of book keeping you can stay in control of your cryptocurrency. If you don’t, the IRS will eventually build software to track down trades and/or subpoena more cryptocurrency exchanges.
Interested in some of the tools and services out there? Tune in to Part 3.
