Did you invest in bitcoin, Litecoin, Ethereum or any other cryptocurrency last year? Well, if you’ve reaped gains (and you probably did if you sold cryptocurrency in 2017), then the IRS wants a portion of your money.
In 2017, Bitcoin reigned supreme as one of the baddest “B” words on the internet. People were either trying to get on the bitcoin bandwagon or stating a compelling argument against it. There were even executives from the big four accounting firms who were encouraging students to buy bitcoin in order to immerse themselves in the technology that could potentially revolutionize the financial services industry.
Buying bitcoin is one thing but selling it is another. When you sell any cryptocurrency, you are subject to taxation under the IRS rules. And the IRS takes taxation very seriously.
If you want to avoid a bad relationship with the IRS, here’s what you should know about cryptocurrency and taxes during tax season:
Report Cryptocurrency Activity on Form 8949 and Schedule D
If this is your first time reporting cryptocurrency activity for taxes, you should become familiar with Form 8949. This form is used to record “Sales and Other Dispositions of Capital Assets.” In other words, you need to report any gains and losses from the sale of stocks, artwork, and other investing activities on this form and include it on Schedule D. Because cryptocurrency trading is considered an investing activity, you have to follow the rules for disclosing capital gains and losses.
Short-Term Capital Gains Taxed as Ordinary Income
When did you start buying cryptocurrency? Did you sell it within a year of the purchase date? If so, you are responsible for reporting a short-term capital gain. A short-term capital gain is calculated on assets held for one year or less and is taxed as ordinary income.
Long-Term Capital Gains Receive Favorable Tax Treatment
If you kept your cryptocurrency for over a year before you sold it, you’re in luck. You’ll
be able to get away from the high ordinary income tax rates and take advantage of preferential long-term capital gains rates. The maximum rate you’ll pay is 20% if you are a high net worth individual. Additional taxes may apply if your income exceeds IRS thresholds.
Use Basis to Calculate Capital Gains & Losses
You need to know your basis before you calculate capital gains or losses. Basis is all the costs incurred in the purchase of the asset. This includes the fees and charges you had to pay to purchase the cryptocurrency. It’s important to maintain proper records and documentation to ensure you calculate the amounts correctly.
You can subtract the amount you received when you sold the asset from your basis to determine your capital gain or loss. First-in,-first out (FIFO) accounting method is typically used for determining the cost basis of the cryptocurrency.
Tax Rules for Cryptocurrency Are Evolving
The IRS is actively working to put more rules in place to manage cryptocurrency transactions. Although the appeal of cryptocurrency is largely due to its decentralized features, the IRS is working to make sure they have a stronger grasp on these crypto assets by tracking how it is used and reported.