Tax Guide to Cryptocurrency Investments

Daniel Penzing
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If you invested in Bitcoin or another virtual currency, you have to report it to the IRS.

Even in the absence of recent developments in the crypto-currency market, the taxation of investments in virtual currencies is an important topic. The IRS recently issued a notice indicating that virtual currency is treated as property under U.S. federal tax law.

This makes it necessary to pay taxes on your crypto-currency holdings (e.g., having to pay taxes on gains from selling your digital currency). We also obtained a clarification of the taxation of mining and trading digital currencies. The following summarizes the main points mentioned above:

If you are trading or investing in crypto-currencies, there are important tips from the IRS about the taxation of your investments in virtual currencies.

If you sell or trade your crypto-currency, you will be taxed on the capital gains (or losses) that you have realized. If you sell your digital currency for cash, the fair market value of the virtual currency is considered to be the cash that you have received. If you get paid in virtual currency, the fair market value is the value of the virtual currency in US dollars.

You can also use a virtual currency to pay for goods or services. When this happens, it is like a barter transaction, which means that you have to pay for the goods or services you received in the virtual currency. The amount of money you have to pay will then be determined by the fair market value, which is calculated by:

What Is Cryptocurrency?

Cryptocurrencies are digital assets designed to work as a medium of exchange or as a form of digitally encrypted money. A cryptocurrency is not as easily counterfeit or falsified as actual money is.

A digital wallet is used to store your digital currency. Wallets generally have 2 parts: a public address, where others can deposit funds, and a private address, where the owner of the wallet can access all funds.

The technology behind it is somewhat complex, it is however gaining more momentum in the investment world.

The first cryptocurrency was introduced in 2009: Bitcoin. Today, there are more than 1000 different cryptocurrencies.

Cryptocurrencies are a relatively new phenomenon and are utilised in a wide variety of ways. They are definitely not limited to what has been mentioned here.

How Is Cryptocurrency Taxed?

Cryptocurrency tax can be a confusing topic. Depending on your country and your source of income, the tax you have to pay can vary quite a lot. Most countries tax cryptocurrency investments based on whether the assets are exchanged for real world currency or are held as a commodity. Either way, it is important to understand the tax treatment of cryptocurrency and taxes for your particular country.

How Cryptocurrency Is Taxed

Cryptocurrencies are still very new investment vehicles that are heavily debated within tax types. For now, capital gains tax for cryptocurrencies is defined as Property. This means that for United States based taxes, your crypto-investments are taxed at the fair market value when you exchange them. This is different from assets that have used a local currency due to their low capital gains tax in relation to other investments like real estate.

If your cryptocurrency has gone up in value since you acquired it, this means the price has changed slightly from its dollar value. You will need to research individual exchanges to find out the price history as some don’t have prices available all the time. You can then compare your current cryptocurrency value to the price you acquired it for. The proceeds received from the sale of assets or cryptocurrencies is treated as personal income. The cost basis of the cryptocurrency is the same as the cryptocurrency fair market value. This means you take the value of your cryptocurrency at that time as the base for your capital gains taxes.

Short-term vs. Long-term Capital Gains

Before you buy, it’s important to understand your tax liability. A general tax principle is that you only pay taxes on the money you make – not on the value of something when you purchase it. This means that if you hold onto something for a long time, you’re generally less likely to be taxed on a sale. This also means you have an opportunity to defer the taxes until you’re in a higher tax bracket … or until you come into a higher tax bracket.

If you hold onto something for less than a year, that profit is treated as a short-term capital gain.

If you hold onto something for more than a year, that profit is treated as a long-term capital gain.

Generally speaking, the lower your tax bracket, the better off you’ll be in the long-term.

However, keep in mind that it is very important to pay federal taxes on your crypto gains, but if you live in a state with an income tax, make sure you pay it on time, too. These are all areas where crypto can open up big tax savings opportunities.

Taxable Cryptocurrency Events

Each year, you may qualify for certain opportunities to defer, lower, or eliminate your tax bill. Here are some of the most important events related to cryptocurrency that you’ll want to keep in mind.1

What About Taxes When Mining Cryptocurrency?

As cryptocurrencies have grown in importance, there has been a growing interest in cryptocurrencies as an investment opportunity … and, accordingly, the government has been paying a great deal of attention to them as well. However, with the number of different cryptocurrencies now available, it is sometimes difficult for the average investor to keep up with them all, and the government has not yet taken a position with respect to all of them.

For example, the IRS recently issued a notice providing guidelines on the tax treatment of Bitcoin and other virtual currencies. It stated that virtual currencies are treated as property, and the notice provides various guidelines on how to file your tax return accordingly.

Because the IRS considers virtual currencies to be property, this means that they’re subject to the same rules that would generally apply to the sale of stocks, bonds, or other kinds of real estate investments. There are a few important things to keep in mind regarding these rules:

The “fair market value” of virtual currency is generally determined as of the date of receipt, or the date when you acquired it.

In addition, the fair market value of virtual currency is generally determined by the price in U.S. dollars as posted on an online exchange.

Tax Planning With Cryptocurrency

Everything You Need To Know

From the IRS's perspective, digital currencies have always been considered taxable property, but the agency has never released concrete guidance on how they should be treated. This limbo has had a significant impact on taxpayers and organizations of all shapes and sizes.

The IRS finally published specific guidance about cryptos in Notice 2014-36, which was released in early April. Although the new guidance was publicized and had been anticipated for months, the announcement was still warmly received by both the digital currency community and tax professionals.

The broad purpose of the IRS notice, as seen from its title, is to present "guidance on the federal tax treatment of virtual currencies." To provide this treatment, the notice examines regulation with three main areas: income tax, payroll tax and information reporting. General tax principles are noted, but they do not constitute the crux of the guidance.

Income Tax

Under the guidance presented, the determination of whether or not an individual's revenue is derived from a virtual currency is based on the taxpayer's "tax specialty" – in other words, in which professional capacity a person earns revenue.

In the case of a user who buys and sells virtual currency in order to profit from fluctuations in the market, revenues will be treated as income.

Calculate the Cost of Your Cryptos

There are several ways to calculate your cryptocurrency capital gains.

The first way is through a fiat gateway. Kraken, Coinbase and Gemini are examples of exchanges that can calculate gain/loss information through their fiat gateway.

If you invest through these exchanges, there is a record of the amount you put in, and the amount you got out. This will make it easier for you to fill out your taxes, simply by subtracting what you put in from what you got out. This is easy to do, but useful only if you keep all of your cryptocurrencies in the exchange itself.

The second option is to track all of your purchases on a blockchain explorer. There are third-party sites like that can track each transaction and calculate gains for you. The advantage is that this option allows you to track your entire portfolio.

The third method is to calculate the gains yourself on a "paper" portfolio. This first requires that you keep a record of your purchases for the entire year. This is time-consuming, but is accurate.

You must also be aware that this is how the IRS views gains on cryptocurrencies. This means that there is no simple formula you can apply to all investments. Each transaction has to be honestly evaluated.

Be sure to record your capital gains and losses correctly to avoid any unwanted surprises in the future.

How Do I Actually File My Crypto Taxes?

Cryptocurrency is a completely new entity in the investment world, and the IRS is still trying to figure out what they can do to be able to follow where the money goes as it gets converted into many other currencies.

IRS officials have announced that they are updating their software to be able to accommodate the cryptocurrency market, but there still isn’t much information on any specific plans they have in motion. As more tax laws and regulations are established, you should be aware of how they affect you if you choose to invest in cryptocurrency.

The IRS currently cares only about gains and losses based on the value of the cryptocurrency when you bought it. This system is obviously about to change, especially as different crypto coins are associated with different uses and different companies, and it will be impossible to keep track of them all.

This makes it imperative to make wise decisions about exactly what you choose to invest in. Some currencies may rise and fall over time, but others may become stable. If you are new to the world of investing in cryptocurrency, here are some useful tips to get your started.

Understand the System

If you are serious about investing in cryptocurrency, then you need to be serious about reading up about the different companies you may choose to help you get the most out of the investment.

The more you know, the better chance you have of making wise decisions.

Make Sure You Report Your Crypto Gains and Losses

If you made money by investing in bitcoin or alt coins, you may need to pay taxes on your gains.

Remember: Your crypto gains and losses are reportable as capital gains or losses.

If you’re a casual investor, you’re in the clear.

But if you’re a trade-heavy investor who profits from short term trading, you’re likely to get a tax bill when it comes time to file your taxes. Why? Because capital gains are taxed as income, and they include short-term or long-term profits or losses from the sale or exchange of capital assets.

Your crypto investment gains are reportable as part of your income, and you pay taxes on that income.

The government doesn’t care if you made money on crypto in 2017 and withdraw it from the exchange in 2017.

The government only cares that you made money on crypto in 2017.