Are cryptocurrency gains taxable?
If you invested in Bitcoin or another cryptocurrency last year, you may be kicking yourself right now, because it hasn’t exactly been the best performing asset lately. On the other hand, you may also be relieved that it’s not worth as much as it was back then, because if that were the case, you would owe quite a bit of money in taxes to the IRS. So are cryptocurrency gains taxable? In many cases, yes! Before we get into why this happens and what you can do about it, let’s get some background on Bitcoin first.
Cryptocurrency gains – what is it?
Cryptocurrency is a digital or virtual currency that uses cryptography for security. Cryptocurrencies are not issued by any central authority and exist only as software on a decentralized, peer-to-peer network. These digital currencies use decentralized control as opposed to centralized electronic money and central banking systems. The decentralized control of each cryptocurrency works through distributed ledger technology, typically a blockchain, that serves as a public financial transaction database. Crypto refers to cryptographically secured transactions which are signatures (cryptographic keys) used in place of sending information directly from one person/entity to another. For example, instead of Alice sending Bob $5 USD via PayPal, she would send him a cryptographic key to unlock $5 USD worth of Bitcoin stored on Bob’s behalf. A wallet stores these cryptographic keys used to unlock data stored online or offline in an encrypted format. As long as you have your private key(s), you can unlock your funds regardless if it’s stored online or offline. If someone else gets access to your private key(s), they could steal your funds without you knowing about it until it’s too late!
The pros and cons of claiming your cryptocurrency gains
So, what are some of these potential pros and cons of claiming your cryptocurrency gains? Let’s start with a basic example: Sally owns one bitcoin worth $4,000. One year later, that bitcoin is now worth $8,000. How much tax will she have to pay on her unrealized capital gain (i.e., her profit)? If you ask five different accountants or tax lawyers, you might get five different answers. The reason for this confusion is twofold: 1) there isn’t any clear guidance from Congress or the IRS about how to treat cryptocurrencies; and 2) even if there were guidance, it would be subject to change over time as cryptocurrencies continue to evolve. That said, most experts agree that if you hold onto a cryptocurrency for more than a year before selling it at an appreciated value, then it should be treated as long-term capital gain and taxed accordingly. If you sell it after holding it for less than 12 months, then it should be treated as short-term capital gain and taxed accordingly. Finally, if you trade in and out of a cryptocurrency within 12 months without actually owning it for that entire period, then those trades are considered ordinary income—and taxed accordingly. As you can see, figuring out whether or not your cryptocurrency gains are taxable can be complicated—especially since many people trade in and out of crypto frequently—but hopefully our simple examples above helped clarify things. In summary: You only need to worry about paying taxes on your crypto profits if they’re considered capital assets. If they’re considered inventory property, then you don't need to worry about paying taxes until you actually make a sale.
Cryptocurrency isn’t like regular income
The IRS treats Bitcoin and other cryptocurrencies like property for tax purposes. That means that any time you buy something with a cryptocurrency, it’s like you’re selling that currency for dollars—you owe capital gains tax on whatever you make from the sale, and must report it on your taxes. You also need to calculate your cost basis when you buy something using crypto: The purchase price is what you paid in U.S. dollars (or another fiat currency), plus any fees or transaction costs. Your cost basis is then used to determine how much of a gain or loss you have when you sell or exchange your digital coins. This can get complicated fast; if you don’t want to deal with calculating all of those gains and losses yourself, consider hiring an accountant who specializes in crypto transactions.
Step 1: Look at the amount you have gained or lost.
The IRS considers cryptocurrencies as property, so you must include your capital gain or loss in your income when calculating whether you owe taxes. If you’ve bought bitcoin with USD and are now selling it for more USD, then congratulations! You have a tax-deductible investment. Don’t cash out of crypto to make fiat purchases unless you want to be paying taxes on that part of your income (you can use FIFO for that). Step 2: Figure out how much it is worth at its current price.: Crypto changes value daily, so figure out how much it is worth based on what it was worth when you made that purchase. For example, if you bought one BTC for $5,000 and sold it for $7,500, then it’s pretty easy to calculate. Just take $7,500 minus $5,000 equals $2,500. However if you purchased five BTC over time at different prices (say one BTC for $3k back in 2013) than figuring out how much those five BTC are worth might be trickier. Step 3: Subtract your cost basis from the sale amount.: This gives you your net profit/loss on each coin/token. For example if we subtract our initial cost basis ($3k) from our sale amount ($7k), we get a net profit of $4k per coin/token. That means if we had an equal number of coins/tokens before and after, then they would be considered long term holdings since they were held for over 12 months. Long term holdings are only taxed upon being sold - there is no tax due during ownership. Step 4: Calculate your total profit across all coins/tokens.: If you have multiple coins/tokens with varying lengths of holding period, find their average holding period by adding up all periods (e.g., 1 year + 1 month + 4 years = 5 years) and dividing by total number of tokens owned (in our case 5 tokens). Your average holding period would be 5 years / 5 tokens = 1 year hold time per token.
Step 2: Take into account any losses you have made on your crypto investments.
If you've sold any of your cryptocurrency investments at a loss (meaning for less than you paid for them), you can deduct these losses from your total capital gains, effectively reducing your tax bill. But there's an important catch: You can only deduct $3,000 worth of losses per year ($1,500 if you're married and filing separately). So be sure to document all of your transactions—it could save you hundreds or even thousands in taxes. It may also be helpful to look into tax-loss harvesting, which is when you sell off certain investments that have lost value but are expected to gain value over time. The idea is that it makes sense to sell off those losing assets now, rather than waiting until they bounce back. Since those losses can be used as deductions against other income, it will ultimately save you money on your taxes!
While no one likes paying taxes, it's clear that paying attention to what types of income are taxed differently and taking advantage of potential deductions will make life easier come April 15th. And who knows? By doing some smart planning ahead of time, you might just find yourself having more money in your pocket come tax day!
Step 3: Calculate your net gain or loss.
Here's where you calculate your net gain or loss. The IRS breaks down cryptocurrencies into two categories, property and non-property. For example, if you received five bitcoins when you started mining for coins in 2010 and you still have them today, those are property because they're tangible assets that you hold. On the other hand, if those five bitcoins were worth $200 when you mined them but they're now worth $2,000, that would be a capital gain of $1,800 ($2,000 minus $200). You'd declare it on your tax return as capital gain, short term or whatever type of income is appropriate based on how long you held onto it.
Step 4: Convert it into sterling.
In order to know if and how much tax you’ll have to pay on your digital currency, you’ll need to convert it into sterling. The value of bitcoin has been up and down a lot in recent months, but at time of writing one bitcoin is equal to £8,182 (GBP). Take that figure as an example: if you hold £2,000 worth of bitcoins and sell them for a price of £8,182 each then you will have made a gain of £16,360. That's not all profit - anything above your cost base is deemed capital gain.
If your total net gains are over £11,700 then you will need to pay Capital Gains Tax (CGT).
The rules are pretty complicated, but you don’t need to worry too much as these gains are taxed at 10% (unless you’re a higher or additional rate taxpayer, in which case they will be taxed at 20%). For example, if you had bought £100 worth of Bitcoin back in 2011 when each coin was worth just 9p and sold them all in January 2018 for £11,700 – your net gain would be £11,600. But as there is a CGT exemption of £11,700 (which applies to both married and single taxpayers), only that amount would be subject to tax. So after paying CGT of 10%, your remaining gains (i.e. those over £11,700) would be £1,300. Again, it’s important to note that CGT is charged on total net gains rather than profits made from selling assets.: If you have made capital losses during 2017/18 then these can be set against any capital gains you have made during 2017/18. If your capital losses exceed your capital gains then you can use up to £3,000 of unused losses against income from employment or self-employment in 2017/18 and balance against income from other sources in future years until exhausted.: Capital Gains Tax can seem like a scary thing if you haven't come across it before - especially when it comes to cryptocurrencies such as Bitcoin where prices rise and fall dramatically within hours or even minutes! However, once you understand how it works, there's no reason why you shouldn't be able to take advantage of its benefits.: Most people who make money through trading cryptocurrencies do so using CFDs. These allow investors to speculate on price movements without actually buying crypto coins themselves. This means that their tax treatment is different: CFD traders pay Capital Gains Tax based on their realised profit rather than their unrealised profit (as with actual crypto coins). They also pay Income Tax on any interest earned while holding CFDs - although they are not liable for CGT because they do not own actual coins.