Because cryptocurrencies like bitcoin are treated as property for tax purposes, paying for a good or service with cryptocurrency is treated the same way as if you were to pay for something with another form of property. This means that paying for a good or service with crypto is a taxable event and you realize capital gains or capital losses on the payment transaction. These gains and losses need to be reported on your taxes.
As stated in the official IRS cryptocurrency guidance put out in 2014, you incur capital gains and capital losses tax reporting requirements when you sell, trade, or otherwise dispose of your cryptocurrency—just like you do with other forms of property like stocks, bonds, or real-estate.
In this sense, cryptocurrency trading looks similar to trading stocks for tax purposes.
For example, if you purchased 0.2 Bitcoin for $2,000 in April of 2018 and then sold it two months later for $4,000, you have a $2,000 capital gain. You report this gain on your tax return, and depending on what tax bracket you fall under, you will pay a certain percentage of tax on the gain. Rates fluctuate based on your tax bracket as well as depending on whether it was a short term vs. a long term gain.
On the flip side, if you sold your cryptocurrency for less than you acquired it for, you can write off that capital loss to save money on your crypto taxes.
You can read our complete guide for a deeper understanding of how crypto taxes work.
Okay, so you bought something with bitcoin, and now you’re wondering how to report it on your taxes. Let’s run through an example to illustrate how this works.
Let’s say you bought 0.1 bitcoin for $1,000. Two months later, this same amount of bitcoin went up in value and is now worth $1,200. At this point, you spend 0.05 BTC on a new TV. How is this taxed, and how do you report it?
Remember, buying something with crypto is technically a “disposition” of the crypto asset. In other words, it triggers a taxable event, and you realize capital gains or capital losses on the transaction.
So to calculate your gain/loss you use this equation:
In this example, the Fair Market Value would be the value in USD of the TV that you bought. Since you bought it for 0.05 BTC, which at the time was worth $600 (0.1 is worth $1200), the fair market value of the TV is $600.
Your cost basis is how much you originally acquired the asset for. In this case, your cost basis for 0.05 BTC was $500 (you originally bought 0.1 BTC for $1000).
$600 - $500 = $100 Capital Gain
So in this example of using bitcoin to buy a TV, you report a $100 capital gain—your bitcoin increased in value during the two months you held it. You realize this gain on the disposition of your BTC, which in this case was buying the TV.
You report this capital gain on IRS Form 8949. You include Form 8949 with your tax return for the year. Read our blog post on how to report cryptocurrency on taxes for a detailed walk through of how to complete Form 8949.
As you might have noticed, this process can become very difficult for anyone who hasn’t been keeping strict records of all the payments they’ve made with cryptocurrency and the USD value of those cryptocurrencies at the time of the payment.
Crypto tax software is built to automatically import these types of transactions along with all of your other regular buys, sells, and trades, and historically retrieve the USD prices so that you can create 1-click crypto tax reports.
CryptoTrader.Tax is a tax reporting tool used by tens of thousands of cryptocurrency enthusiasts to automate the entire crypto tax reporting process.
Simply import all of your cryptocurrency payments on step 3 of the app as “outgoing transactions”. As you can see in the picture below, we have added our outgoing bitcoin payment of 0.05 into step 3. You do not need to include the USD value of these transactions (phew) as the software will automatically retrieve the historical prices.
This transaction will now be categorized with all of your other transactions (buys, sells, trades) and included in your tax reports. You can also bulk upload cryptocurrency payments using the CSV import template.
Are you looking to automate your cryptocurrency tax reporting? You can get started with CryptoTrader.Tax for free today. Or click here to learn more about how it works.
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.