Bitcoin tax policies are becoming increasingly important as governments around the world strengthen their bitcoin tax reporting and filing requirements. In most countries including the U.S., bitcoin is treated as property (an investment), and the income generated from the investment is subject to capital gains and capital losses rules.
In this guide, we break down exactly how bitcoin taxes work.
This guide addresses specific crypto tax implications within the U.S., but similar issues arise in many other countries.
The IRS treats bitcoin and other cryptocurrencies as property for tax purposes. Similar to other forms of property (stocks, bonds, real-estate), you incur capital gains and capital losses when you sell, trade, or otherwise dispose of your bitcoin.
The capital gains that you recognize from the sale, trade, or disposal of your bitcoin are a form of taxable income, while capital losses reduce your tax liability.
George purchases 2 bitcoin for $14,000 in May. Two months later, he sells both of those bitcoin for a total of $15,000.
In this scenario, George realizes a $1,000 capital gain from the sale of his bitcoin. This $1,000 gets reported on George’s tax return, and George will pay a certain percentage of tax on this gain. The percentage of tax he pays depends on his personal income tax bracket.
Sandy buys 10 ETH at $200 per ETH, $2,000 total. Four months later, Sandy sells 5 of those ETH for $800.
In this example, Sandy realizes a $200 capital loss (1,000 - 800). This $200 reduces Sandy’s taxable income and lowers the total taxes she owes. If Sandy made $50,000 in income during the year, her new taxable income when factoring in this capital loss would be $49,800 (50,000 - 200).
Simply buying and holding your bitcoin is not taxable. As mentioned above, you only incur capital gains or losses when you dispose of your bitcoin—or get rid of it in one way or another.
So to understand when you must report bitcoin taxes, you need to understand these different types of disposals that trigger taxable events.
A taxable event is simply a scenario that triggers a tax reporting requirement. It’s as straightforward as that. Whenever you incur a taxable event, you incur some sort of tax reporting requirement.
The following have been taken from the official IRS Cryptocurrency Guidance as to which scenarios are considered taxable events within the world of bitcoin:
All of these events are considered to be dispositions of your bitcoin, and you realize a capital gain or loss whenever you carry out one of these actions.
John purchases 0.1 BTC for $500. One month later, he trades that 0.1 BTC for 2 ETH.
As noted above, trading one cryptocurrency for another is considered a taxable event. Effectively, John is selling his BTC and buying ETH. The amount of capital gain or loss that John realizes from this disposition depends on what the fair market value of the 2 ETH that he traded for were.
Let’s say at the time those 2 ETH were worth $700. In this case, John realizes a $200 capital gain by trading his BTC for ETH (even despite the fact that John never ‘cashed out’ to fiat).
The following scenarios do not trigger taxable events:
The equation used to calculate gains and losses is very straightforward, and we have been using it in the examples above.
Fair Market Value - Cost Basis = Gain/Loss
Fair Market Value is the market price of the cryptocurrency at the time you dispose of it, and Cost Basis is the amount it originally cost you to acquire the cryptocurrency.
As you can probably start to tell, doing these gains and losses calculations for every single taxable event that you incur can quickly become challenging.
Let’s run through a more complex, but realistic example to demonstrate.
Lucas buys 0.472814738 BTC on Coinbase for $3,000. The next day, he sends that BTC to Binance to start trading various altcoins. Lucas then makes the following trades:
For these transactions, Lucas needs to use the equation from above to calculate his gain or loss for each trade. Lucas needs to know the USD cost basis of the asset he is disposing of as well as the USD fair market value at the time of the trade.
Many bitcoin investors have been trading for months, sometimes years, and haven’t been keeping records of their trades. As demonstrated above, you need to be keeping track of the USD value for all of your cryptocurrencies at the time you traded them so that you can calculate your capital gains and losses and properly report on your taxes.
These tax reporting requirements are tedious, and this is the reason why hundreds of thousands of bitcoin investors are leveraging bitcoin tax software to automate the entire capital gains and losses reporting process.
We’ve discussed how the capital gain and loss calculation process works for your bitcoin disposals. But how do you actually file these with your taxes?
IRS Form 8949 is the tax form used for reporting the dispositions of capital assets—like bitcoin. It’s on this form that you document each taxable event and the associated gain or loss that resulted from the event.
The image below shows how 8949 would be filled out for a number of ETH dispositions.
As you can see in the image, you need to include:
The video below demonstrates the process of filling out Form 8949.
Once you have reported each of your trades on 8949, simply add up the gains and losses column to arrive at a total net capital gain or loss. This net number gets transferred to 1040 Schedule D of your tax return.
There are a number of factors that affect the actual tax percentage you pay on your bitcoin gains. We address these below.
Holding your bitcoin for less than or longer than one year has tax implications.
If you hold your bitcoin investment for less than 12 months before disposing of it, you are taxed at the short term capital gains tax rate. These rates are the same as your marginal income tax bracket. In other words, Short Term Capital Gains are taxed as income.
The image below depicts the short term capital gains tax brackets.
On the other hand, if you hold your bitcoin for longer than one year (12 months), you are taxed at the Long Term Capital Gains tax rates. These brackets are depicted below.
As you can see, there are significant tax incentives to hold your bitcoin for longer than one year to take advantage of these long term rates.
Bitcoin and crypto tax calculators like CryptoTrader.Tax can help you identify which assets in your portfolio qualify for long term capital gains treatment vs. which ones you may want to continue to hold onto.
To this point, we have only discussed capital gains and capital losses associated with bitcoin trading and investing, but what if you earn bitcoin? How do the tax implications work?
When you provide a product or service for someone and are paid for that work, the income you receive as compensation is a form of taxable income.
The same applies to bitcoin mining. You are providing a service and are being compensated for that service in bitcoin. The value of the bitcoin you earn is taxable income.
Put simply, you recognize income at the USD fair market value of bitcoin at the time you receive it.
Sara runs a mining rig in her basement and earns 0.05 BTC on July 2nd as a mining payout. At this time, 0.05 BTC is worth $400.
Sara recognizes $400 of income from this mining payout, and it gets reported on Sara’s taxes.
Sara’s cost basis in that 0.05 BTC that she now possesses is $400—the amount she recognized as income. If she sells that 0.05 BTC a month later for $500, she recognizes a $100 capital gain.
For a more detailed look at bitcoin mining tax implications, checkout our bitcoin mining tax guide.
Bitcoin exchanges like Coinbase, Binance, Kraken, and others actually do not have the ability to give their users accurate gains and losses reports most of the time. This problem is little understood, yet it affects millions of users.
Because bitcoin is transferable, i.e. you can send it from one wallet to another, exchanges don’t have the ability to track the cost basis of your assets.
When you transfer bitcoin into or out of an exchange, that exchange has no way of knowing how, when, where, or at what cost basis you originally acquired your bitcoin. This transferability makes it impossible for exchanges to give users gains and losses reports in USD terms.
We wrote extensively on this topic in our blog post, The Cryptocurrency Tax Problem.
You can see below how Coinbase themselves explain this problem to their users.
The solution to the bitcoin tax problem revolves around being able to properly keep track of the cost basis of your coins as they are transferred from one wallet to another.
To do this, you need to aggregate the transactions that make up your buys, sells, trades, conversions, airdrops, and mined coins into one unit of record.
Once you have all of your transaction history in one place, you can track the cost basis of your coins and carry out the necessary capital gains and losses calculations for your tax reporting.
Bitcoin tax software like CryptoTrader.Tax exists to solve this problem and to automate the entire bitcoin tax reporting process.
By integrating with major exchanges and platforms, CryptoTrader.Tax allows users to import their historical transactions directly into their account. Once this data is imported, users can generate capital gains and losses reports as well as an auto-filled Form 8949 with the click of a button.
These tax reports that CryptoTrader.Tax generates based off your historical data can be taken to your tax professional or imported directly into your preferred tax filing software like TurboTax or TaxAct.
You can import all of your transactions and get a preview of your capital gains and losses completely for free with CryptoTrader.Tax. Learn more about how it works here.
Of course no one can say for sure what exactly will happen if you don’t file your bitcoin taxes. However, the IRS has made bitcoin tax compliance one of their top priorities in recent years.
In 2019, the U.S. tax collecting agency sent out more than 10,000 warning and action letters to bitcoin investors who were suspected to be misreporting their bitcoin income on their tax returns. This scrutiny is expected to increase after the IRS added a new question to everyone’s tax return, asking if you have ever invested or had any financial interest in any virtual currency. Over 150 million U.S. taxpayers will have to check ‘yes’ or ‘no’ to this new question on their tax return.
In the U.S., tax fraud is subject to a number of penalties, including criminal prosecution, five years in prison, along with a fine of up to $250,000.
Disclaimer - This post is for informational purposes only and should not be construed as tax or investment advice. Please speak to your own tax expert, CPA or tax attorney on how you should treat taxation of digital currencies.