Bitcoin has presented millions of individuals around the world with a unique opportunity to generate a massive amount of revenue through intelligent investing. Many successful crypto investors and entrepreneurs, however, overlook a critical factor when generating profits from Bitcoin- the tax man.
The IRS began issuing guidance on the taxation of Bitcoin in 2014, when the currency began to filter into the perception of the global financial zeitgeist at large. At the date of this first official statement from the IRS, the agency determined that Bitcoin would be treated as property, with loss or gains treated as either capital loss or capital gains for taxation purposes.
Recent statistics released by the IRS, however, show that Bitcoin tax reporting is only infrequently performed by crypto investors. In 2015, only 802 investors declared their Bitcoin-related gains or losses to the agency, which sparked a chain of events that led the IRS to begin investigating alternative methods of identifying Bitcoin financial action.
The IRS has recently partnered with Chainalysis, a startup that offers a powerful toolset that provides the agency with the ability to track, visualize, and analyze Bitcoin transactions in an attempt to unmask Bitcoin investors and dip their fingers into the proverbial crypto pie.
Other actions taken by the IRS to target Bitcoin traders is the pressure it has recently placed on Coinbase to reveal the identity of all users that traded more than $20,000 USD in Bitcoin between the years of 2013 and 2015. Given the crypto-anarchic roots of Bitcoin, it’s easy to understand why many investors view taxation with a cavalier perspective, but these recent developments give the impression that the tax man is slowly but surely catching up to crypto entrepreneurs.
In this article, we’ll break down the basics of Bitcoin taxation and present the simplest ways to report your investment income to the IRS.
How Is Bitcoin Categorized By The IRS?
The IRS views Bitcoin and other digital currencies as “intangible property” with regards to Federal tax purposes. This classification requires Bitcoin investors to present their financial actions concerning digital currencies using Form 8949, which is the same form used to declare losses and profits on a bonds or stocks portfolio.
Additionally, individuals that receive Bitcoin as payment for goods and services rendered are required by the IRS- who view these Bitcoin payments as standard income- to declare these payments under standard income tax guidelines.
Best Way To Report Your Bitcoin Investment Income To The IRS?
In order to get started with reporting your Bitcoin or digital currency investment income to the IRS, it’s important to have an understanding of the realization method that is used to calculate it. Instead of mark-to-market accounting, digital currency investment income requires individuals record the total profits or losses realized after selling all or part of their Bitcoin investment, as opposed to the value of Bitcoin at the time of tax reporting.
Each individual Bitcoin trade must be recorded separately on the Sales and Other Dispositions of Capital Assets Form 8949, which ensures transactional transparency when the taxation authority assesses the tax report- as opposed to summary reporting, which doesn't provide the IRS with a clear and concise image of your financial actions.
It’s also important to utilize the holding period rules that apply to Bitcoin, and divide digital currency investment income between both short term and long term- which is qualified as 12 months or longer- realized gains or losses. As the capital gains tax rates on long term realized gains or losses are more lenient, it’s often beneficial to separate digital currency investment income between the two disparate holding period rules.
Another important fact to note is that the $3,000 capital loss limitation against other income sources also applies to digital currency income, which applies if you have experienced investment losses in the tax year.
Bitcoin Taxation Software
Many digital currency investors choose to track their Bitcoin or other digital currency trades through a spreadsheet for tax purposes, but if you’re in the habit of making a significant amount of trades, this technique can quickly become cumbersome. While exchange trade history can help to mitigate the onerous task of logging every trade, Bitcoin and digital currency taxation software can lessen the load significantly.
Platforms such as Coin Reporting and Bitcoin Tax provide digital currency investors with simple, streamlined, and easy-to-use methods of tracking digital currency transactions for tax purposes, and are able to assist traders in keeping track of financial actions to ensure their tax reporting is up to standard.
If you’re still unsure of the best way to go about reporting your digital currency income to the IRS, it’s advisable to consult with your tax advisor or a financial expert to ensure that you are fulfilling your reporting obligations to the letter.
Bitcoin Taxes, IRS Tracking Software & Cryptocurrency Classification Conclusion
Overall, digital currency and Bitcoin investment is a highly lucrative venture, but, as with any profitable endeavor, it’s critical to ensure that the tax man remains satisfied. Both capital gains and losses resulting from Bitcoin investment- or any other digital currency- must be reported to the IRS via the relevant documentation.