If you were one of the early birds to get into the bitcoin race, I know you’re probably wondering what your tax implications are. As with all other investments and money, it’s wise to think about how taxes will impact the end results. Unfortunately, ignoring taxes won't just get expensive. It can also get you into a bit of trouble with the IRS.
I've gathered the most essential information regarding how bitcoin taxes work to help you out. You will also learn about crypto taxes in general and all the essential regulations to keep in mind.
How Is Bitcoin Taxed?
Bitcoin is going to be taxed as an asset. Therefore, like any other asset you have, you will have to report bitcoin to the IRS and pay the appropriate taxes for any profits. When bitcoin first came out, many people thought that this might be a way around having to pay taxes on significant investments; however, I can guarantee that’s not the case.
The IRS has made it mandatory for all taxpayers to report bitcoin transactions. Therefore, even if you're working with minute amounts or small transactions, you will have to pay the appropriate taxes.
It is important to remember that bitcoin is not the only cryptocurrency that is taxed. Regardless of the cryptocurrency that you prefer to work with, you will have tax implications that come along with it.
If you don’t correctly report the income you're making from your bitcoin earnings, you will, unfortunately, have to pay penalties to the IRS. If those penalties aren’t paid, there is interest and potentially prosecution involved in the process as well. No one wants to deal with that!
The point I’m making here is that you need to prepare to pay taxes on the cryptocurrency investments that you have.
Is Crypto Tax Different Than Other Taxes?
Now that you know that cryptocurrencies, including bitcoin, need to be taxed, I’m going to walk you through whether this tax is different in any way. It seems straightforward that you would just report your bitcoin earnings the way you would any other earnings, right?
Well, it can get complicated. The problem that bitcoin owners run into is the way that the pricing of the bitcoin changes. It makes it tough to determine what the fair value of the cryptocurrency is at any given time.
There are accounting processes in place that allow you to ensure you're not making too much untaxed profit on your crypto investments. The first-in, first-out method of accounting tends to be used for cryptocurrency. For example, the first share of bitcoin that you purchase is the first one that is sold. This helps to show the increase in profit over time and how it will impact your tax return.
The issue with using other accounting methods like last in, first out, is that some investors will know how to work the system to avoid portions of their taxes. Crypto taxes are top of mind for the IRS. As more and more people get involved with these cryptocurrencies, I’m expecting to see stricter tax laws and more and more involvement in how these procedures are handled.
If you think investing in bitcoin is a way to avoid some taxes on your investments, I advise you to think again. Bitcoin tax is just like any other tax you're subject to.
Do You Pay Taxes When You Buy Bitcoin?
You should definitely anticipate paying taxes when you buy bitcoin. Don’t forget to report it on your tax return at the end of the year. There’s no way to avoid the short-term capital gain or loss that you may experience because bitcoin taxes will be just as much as it would be for your typical capital gains tax. Depending on your income bracket and how much profit you make, you could be looking at a whopping 37% percent.
What Bitcoin Transactions Require You to Pay Taxes
As you can probably imagine, I field many questions from readers regarding paying taxes and reporting on bitcoin earnings. Here are some of the basic requirements that I've compiled about bitcoin transactions and which ones will require you to pay taxes.
Asset & Property
Since bitcoin is considered an asset or property by the IRS, owning bitcoin will require you to pay taxes. This means that you will also need to know what you purchased the bitcoin for and its current market value when the time comes to pay taxes.
Many bitcoin investors like to use their bitcoin as a way to pay for things. Some bitcoin exchanges have tens of thousands of merchants that will accept bitcoin as payment. Convenient, huh? However, when you're shopping for goods, you will still have to pay tax as you would if you were using cash or credit card for your shopping. This is because bitcoin retail transactions are always taxed, as I mentioned above.
Bitcoin Mining Businesses
It shouldn’t be a surprise at this point that those in the field of bitcoin mining will also be subject to capital gains tax. Bitcoin miners are business owners and will have to file their tax returns as such. Business owners have to pay taxes on any of the profits they make, including the mining of bitcoin. However, there are more deductions that business owners can take that a typical bitcoin investor may or may not be eligible for.
Gifting or Inheritance
If your uncle happens to give you several bitcoin shares for your next birthday, you will still be subject to taxes on these. My guess is that knowledge makes you second guess your birthday wishlist this year!
The way bitcoin gifting or inheritance is treated is essentially the same way property, or cash transactions are handled. However, there will be certain limits and rules that are necessary to follow. As always, it is important to talk to a tax expert before giving someone bitcoin.
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Keep Records to Properly Record Bitcoin Taxes
At this point, you should have a pretty good understanding that your bitcoin investments are going to end up costing you a bit of money in taxes. As I like to say, the good thing about paying taxes is that you have to be making money to owe money to the government.
One of the best tips I can give a person interested in getting involved in bitcoin investing is to make sure that they keep adequate records right from the start. If you can be sure that your records are accurate, you won't have to worry about the mess of filing your taxes at the end of the year.
So, keep a clear record of when you buy your bitcoin and what the fair market value is when you sell it. This information will be crucial at the end of the year. The better your records, the easier it will be for your accountant (or TurboTax) to work out the tax return.
Some cryptocurrency wallets may help you with your record-keeping, but things get a bit tricky when working with different crypto types, and you will have to work a bit to keep it all sorted out.
Bitcoin Taxes Recap
I know that taxes can get confusing quickly. But, what I’m trying to get across is that the taxes paid on bitcoin are similar to other property or assets that you currently have in your possession. When you file your next tax return, I highly recommend that you have all your ducks in a row about your bitcoin trading history throughout the year.
You don’t want to face penalties and other issues in the future, right? I know I don’t. That’s why you have to make sure that you fully understand what is involved with bitcoin taxes. If you're unsure how to accurately report bitcoin this coming tax year, talk to an accountant or tax professional.
Yes, you have to report Bitcoin on your taxes, according to the IRS. The way that Bitcoin is reported is just like any other property would be. So, if your Bitcoin lost value since last tax season, you would also report this on your taxes. Bitcoin investments and any crypto investment can either increase or decrease your taxes depending on how much money you have made or lost throughout the year.
As mentioned throughout this article, Bitcoin is taxed at your capital gains rate.
The transactions you make with Bitcoin are recorded as part of your tax return. This information is sent to the IRS so that your return and taxes charged are accurately calculated. I highly recommend that any Bitcoin users reading this keep detailed records of their trades so they don’t owe more than they should. It’ll also prevent you from underpaying and facing the consequences later on.
There is no legal way to avoid taxes with Bitcoin, and I definitely wouldn’t suggest doing so. Many people tried to trade between cryptocurrencies attempting to evade taxes, but the IRS stopped this.
One idea is that you could invest your Bitcoin earnings into your IRA to help save taxes on the front end. This is a decision that you should talk to your financial advisor about to see if you’re eligible and if it will benefit you in the long run.