The value of Bitcoin continues to fluctuate, but for the most part it's going up. If you’re thinking about joining the volatile world of cryptocurrency trading, just be aware that whatever you buy, sell, exchange, or mine is taxable. Here’s what you need to know about crypto taxes:
What is cryptocurrency?
The IRS defines cryptocurrency as “virtual currency”. It functions similarly to cash, but it is purely digital, which means that it doesn’t come in a physical form, whether in bills or coins. If U.S. currency is called “dollars”, cryptocurrency units are called “coins”. These coins are stored in virtual wallets and exchange platforms where users can buy, sell, or trade cryptocurrencies such as Bitcoin and Ethereum.
In some countries, cryptocurrency can be used to purchase goods and services, to invest, or to exchange for normal currency. Every cryptocurrency transaction is recorded in the blockchain, which is like a digital ledger.
Is cryptocurrency taxed?
Yes. Many tax authorities across the globe such as Australia, U.S., U.K., and Canada tax cryptocurrency transactions. In the U.S., cryptocurrency is taxed as property. If your cryptos appreciate when you sell, trade, or use them for profit, they are taxed as capital gains. However, if the cryptos depreciate when you sell, trade, or use them at a loss, you can benefit from reduced taxes.
In general, the following are what tax authorities consider as taxable transactions:
- Selling the cryptocurrency for fiat currency (e.g. USD, EUR, etc.)
- Trading cryptocurrencies (e.g. exchanging Bitcoin for Ethereum)
- Buying goods and services with cryptocurrency
- Receiving cryptocurrency from mining
On the other hand, the activities are below are considered non-taxable transactions:
- Buying cryptocurrency
- Donating cryptocurrency to a charity
- Gifting cryptocurrency
- Moving cryptocurrency to and from digital wallets that you own
Since cryptocurrencies are considered property, you’ll need to determine their fair market value. This is the conversion of the virtual currency into U.S. dollars or other currencies. In addition, it’s ideal to keep accurate records from the moment you enter the crypto world. Reconstructing years of transactions can be impossible, so it’s best to keep things as organized as possible.
What happens if you don’t file your cryptocurrency taxes?
In the U.S., taxpayers are required to declare whether they performed cryptocurrency transactions in the past year. Even if you don’t buy, sell, or trade cryptocurrencies, you will still have to check “yes” on Form 1040 as long as you own cryptos. Tax evasion could result in fines, penalties, tax interest, audits, and jail time. However, in most cases, the IRS will send taxpayers the CP2000 notice if they notice a discrepancy in the documents.
Where should you report crypto taxes?
In the U.S., taxpayers are required to file Form 8949 in Form 1040 Schedule D. This form is used to report a taxpayer’s capital gains and losses on crypto.
You’ll also need to file your annual income tax returns using Form 1040 Schedule 1, where you can find the new crypto question at the top that asks whether you received, sold, sent, exchanged, or acquired any financial interest in any virtual currency in the past year.
If you stick to non-taxable events such as transferring cryptos between wallets, you won’t have to worry about paying taxes on your cryptos. However, if you haven’t been reporting your crypto transactions in the past two years, you may need to consult a CPA who’s an expert on crypto taxes.