The value of most Cryptocurrencies has skyrocketed over the last six months. Although there has been a recent fall in prices, if you invested in a Cryptocurrency or received it as payment before December 2017 you are still probably sitting on a substantial financial gain.
As with any financial transaction you are subject to tax in the United States if you are a US citizen. The IRS has been very clear on this since 2014, it’s therefore important for you to understand whether you have a tax liability and how much that liability may be.
This short article will give you some guidance as to how you might begin to figure out what that tax liability might be.
How Cryptocurrency is defined by the government
According to the IRS virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. That describes Bitcoin or any Altcoin you may hold or have sold at a profit. The IRS has stated that the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability.
For federal tax purposes, Cryptocurrency is treated as property. General tax principles applicable to property transactions apply to transactions using Cryptocurrency. Under the currently applicable law, Cryptocurrency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
This is an important technical distinction to note as many people view Crypto trading like forex trading, the IRS ,however, view it as a sale of property.
When does a tax liability arise?
Taking payment in Cryptocurrency
A taxpayer who receives Cryptocurrency as payment for goods or services must, in computing gross income, include the fair market value of the Cryptocurrency, measured in U.S. dollars, as of the date that the Cryptocurrency was received.
For U.S. tax purposes, transactions using Cryptocurrency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of Cryptocurrency in U.S. dollars as of the date of payment or receipt. There is an easy way to calculate the fair market value If a Cryptocurrency is listed on an exchange and the exchange rate is established by market supply and demand.
The fair market value of the Cryptocurrency is determined by converting the Cryptocurrency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.
If you are self-employed and received Crypto as payment this includes you too. Self-employment income includes all gross income derived by an individual from any trade or business carried on by the individual as other than an employee. The fair market value of Cryptocurrency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt is such income too.
Making an investment gain from trading Cryptocurrency
A taxpayer generally realizes capital gain or loss on the sale or exchange of Cryptocurrency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. For most investors in Cryptocurrency, their coins will be a capital asset as they are bought as an investment, not as part of any business.
If this is you then you have to make a capital gains tax (CGT) payment on any gain.
For tax and accounting purposes, capital gains and losses are calculated by determining how much your cost basis has gone up or down from the time you acquired the asset. When you calculate your basis, you’ll figure the purchase price plus any related costs, such as commissions.
You need to pay the CGT when you sell or dispose of the Crypto. You may have a taxable event even if you don’t formally cash out. Anyone using cryptocurrency to pay for goods or services must treat each purchase as a sale.
Some exchanges will offer a summary of transactions which can be used to help you file your taxes but if you withdraw cryptocurrency from an exchange, the exchange can no longer track what happens, so you must make sure that you do.
What about mining Cryptocurrency?
When a taxpayer successfully “mines” Cryptocurrency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.
If a taxpayer’s “mining” of Cryptocurrency constitutes a trade or business, and the “mining” activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment (generally, gross income derived from carrying on a trade or business less allowable deductions) resulting from those activities constitute self-employment income and are subject to the self-employment tax.
What if I swap my Crypto for something else?
If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the Cryptocurrency, the taxpayer also has a taxable gain.
Whilst trading or taking Bitcoin or any Altcoin may seem like fun, as many projects involving blockchain technology most certainly are, these activities generate serious financial obligations in the United States.
It is important that you are careful and maintain detailed records of any transactions you make using Crypto, in particular, the equivalent US dollar value of the Crypto at the time of the transaction.
As summarised above your tax liability, be it CGT or otherwise, depends on how you are using Cryptocurrency. This short guide will give you a start, but it is always best to get professional advice when it comes to your exact tax liability, especially if your activity in this area is substantial.
Taxpayers may be subject to penalties for failure to comply with tax laws and they can be very large.
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