Cryptocurrency and Bitcoin taxes are a tricky field to navigate. Even today, IRS guidance remains quite vague, and many CPAs don’t know how to properly file crypto taxes. However, despite confusing or unclear guidelines, the IRS has made it very clear they want you to report your crypto (we’ll expand on that below).
At Gordon Law Group, we’re here to make your tax return simple and virtually audit-proof. We’re happy to say we’ve had a great track record of predicting how the IRS will treat various cryptocurrency activity, based on our experience with foreign asset reporting and other related tax laws.
Here are the top 6 things every trader needs to know about cryptocurrency and Bitcoin taxes:
1. Crypto is treated as property, not currency
Since 2014, the IRS has taken the stance that cryptocurrency is property, not currency. This has major implications when it comes to tax reporting.
The most important effect is that cryptocurrency trading is open to more reporting requirements than currency, which brings us to our next point.
2. Sales, mining, and crypto-to-crypto conversions are taxable events
A “taxable event” means an action that you need to report on your tax return. According to official IRS guidance from 2014, the following are taxable events when it comes to any cryptocurrency, from Bitcoin to the myriad altcoins available:
- Exchanging crypto for fiat: Because cryptocurrency is taxed as property, exchanging crypto for fiat (USD) is taxable, just like selling a house or other property.
- Exchanging crypto for crypto: Yes, converting cryptocurrency is taxable! Again, this has to do with its designation as property. In the eyes of the IRS, exchanging one coin for another is like selling the first coin for USD, then using USD to buy another coin.
- Spending cryptocurrency on goods and services: Since crypto is property, using it for commercial transactions is like selling your crypto for cash, then using the cash for your transaction. Therefore, it’s a taxable event. (Are you sensing a theme?)
- Earning cryptocurrency: Whether you’re mining, accepting crypto as payment, or earning it some other way, this is a gain that must be reported.
On the other hand, the following are not taxable events:
- Transferring crypto between your own exchanges or wallets
- Buying cryptocurrency with USD (it’s not taxable until you use, sell, or trade the coin)
- Gifting cryptocurrency (and yes, you can donate crypto to charity for a tax deduction!). If you gift over $15,000 a year, you may need to prepare a gift tax return—but don’t worry, there is generally no tax due
3. Cryptocurrency and Bitcoin taxes are based on gains and losses
Although you have to report virtually all cryptocurrency activity to the IRS, you will only be taxed on your capital gains. To determine that, you need 2 key pieces of information for every transaction: the cost basis and the fair market value at the time of sale/trade.
How to determine cost basis for your crypto:
The cost basis is how much you paid per coin + any other associated costs, such as transaction fees.
For example, say you invested $1,000 in Ethereum when the value was $200 per coin–so you purchased 5 coins. You also paid a 1.5% transaction fee for the purchase.
In this case, the cost basis is ($1,000 x 1.015) / 5, or $203 per coin.
If you mined your crypto, the operating costs of your software can be counted toward cost basis.
Subtract cost basis from fair market value to determine gains or losses:
Going back to our Ethereum example, let’s say you sell a coin for $500. Since your cost basis was $203, your capital gain is $297. You will only be taxed on the gain.
And what if you had a loss? If your Ethereum coin plummets in value to, say, $25 and you sell it off, your capital loss would be $178. In some cases, this can be very beneficial for your tax position because you can use losses to offset capital gains.
Reporting your gains and losses:
We recommend reporting your gains or losses from every taxable event on your tax return. Even if you only use one exchange and receive form 1099, you cannot simply attach this to your tax return. Instead, you need to prepare a reconciliation and report each of your trades on your tax return. Otherwise, the IRS will have no record of your cost basis and may think you owe much more tax than you actually do.
If you use multiple wallets and exchanges, or you have hundreds or even thousands of crypto trades per day, you can quickly end up with a reporting nightmare.
Software like ZenLedger or Cointracker can help you reconcile your trade data for cryptocurrency taxes, although this will still require a lot of time and effort on your part.
Our crypto tax attorneys can also handle the calculations for you; it’s what we do every day for hundreds of clients. If the thought of calculating your gains and losses is already giving you a headache, call us for a confidential consultation at 847-281-3436.
4. The IRS receives sales data from cryptocurrency exchanges
Think the IRS won’t find out about your crypto trades? Think again. After years of legal battles, all the major US exchanges now provide the IRS with form 1099-K, which reports your total sales volume. Some foreign exchanges are also starting to report.
If the IRS receives information from your exchange and you haven’t reported anything, you could be at high risk for an audit. In addition to whatever cryptocurrency taxes you owe, the typical fraud penalty for failing to report your crypto is 75% of the amount due.
Not only could you be at risk of an audit, but most exchanges only report your total sales proceeds to the IRS—not your cost basis. This tends to make your capital gains appear much, much higher than they actually are and can lead to a massive tax bill.
One of our clients received a notice from the IRS that he owed $400,000! In reality, once cost basis was factored in, he owed significantly less. See how we brought down our client’s tax bill in the video below.
You can avoid a similar situation by fully reporting your cryptocurrency transactions on your tax return. You can also go back and correct your tax returns for prior years. Give us a call at 847-281-3436 to discuss your options.
5. Missing information can still be tracked
Many of our clients ask, “What if I lost my key to an old wallet?” or “What if I don’t have a record of my transactions?” Often, you can still access your trade history; we do this daily by tracing the blockchain. It’s not always possible, but we can often find most of the missing data or at least make close estimates.
The good news: We’ve been very successful at tracking down our clients’ data, even if they’re missing a wallet key or if they haven’t kept track of their transactions. So if you want to reconcile your cryptocurrency taxes for prior years, it is possible to create a full report and keep you in the clear.
The bad news: If we can hunt down your information, so can the IRS. Will they bother to do this for every small-scale trader in the country? Probably not. But if you have significant trade volume or gains, the IRS can indeed track your information. The IRS is the largest collection agency in the world, and it’s turning its sights on cryptocurrency more than ever before.
6. We expect increased crypto tax audits in the future
In 2019, the IRS sent over 10,000 letters notifying crypto holders of their reporting requirements. They also added a legal landmine to the 2019 Schedule C tax form, asking:
At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?
We believe the IRS’s actions are laying the foundation for increased crypto audits going forward. Falsely answering “no” to the crypto question on Schedule C can be a very risky move, as we explain in the video below.
Need help preparing a cryptocurrency tax report, correcting your old tax returns, or fighting a crypto audit? We’ve been in the game since 2014 and have helped hundreds of clients just like you. Call our experienced tax attorneys at 847-281-3436 to schedule your confidential consultation.