Did you dabble in bitcoin in 2017, riding the cryptocurrency roller coaster that seemed to captivate the nation? You may be on the hook for taxes — no matter how you acquired or used it.
You can run afoul of IRS rules on bitcoin in a few surprising ways. Here’s how using bitcoin can affect your tax situation.
Bitcoin is property (and that’s really important)
In 2014, the IRS issued a notice declaring that cryptocurrency is treated like property, not a currency. That may sound like a trivial distinction, but it’s the basis for when the IRS decides whether individuals owe taxes. And these tax consequences revolve around what the government agency calls a “realization event.”
A realization event, as it relates to bitcoin, involves three actions:
- Acquiring bitcoin via mining
- Cashing bitcoin, say, for dollars or euros on an exchange
- Using bitcoin to buy goods or services
In each case the bitcoin owner may have created a tax liability. If you acquired a bitcoin (or part of one) from mining, that value is taxable immediately; no need to sell the currency to create a liability. If you acquired bitcoin through cashing it on an exchange or buying goods and services, you will owe taxes if the realized value (the sale price of bitcoin, for example) is greater than the price at which you acquired the bitcoin.
Selling property isn’t usually associated with a taxable gain, aside from housing or fine art. “Many people think that there’s no tax consequences when they sell an object — it’s for personal use and they’re expecting to lose money on it anyway, whether it be a car, an appliance or another piece of property,” explains Brian R. Harris, a tax attorney at law firm Akerman LLP in Tampa, Florida. “Many people aren’t in the mindset of holding tangible objects for investment and then recognizing gains when they ultimately sell them.”
“But if there’s been a gain from the bitcoin owner’s cost basis, there’s a tax liability,” he says.
That tax liability will be assessed as if it were a capital gain, and taxed at either short-term or long-term rates, as appropriate.
Mind the information gap
That issue of cost basis can be problematic, to say the least. Just as for stocks or bonds, the cost basis is the price at which you acquired the asset. So bitcoin owners need to know not only the price when they realized value but also the acquisition price of their digital currency. That information may not be easily available — and many people have no idea they’re liable for taxes.
Normally with stocks, for example, you receive a Form 1099-B from your broker with the cost basis, but with bitcoin you might not. A Form 1099-K might be issued if you’re transacting more than $20,000 in payments and 200 transactions a year. But both conditions have to be met, and many people may not be using bitcoin 200 times in a year.
“It’s a potential way to run afoul of IRS laws,” Harris says. “You’re conditioned with the receipt of the 1099 to know that you have a taxable event and what that taxable gain is. You don’t always get that with bitcoin. So many people just aren’t being informed from the exchange in a manner that they’re used to.”
Whether you cross these thresholds or not, however, you still owe tax on any gains. While not paying taxes on your gains might be an honest mistake, don’t expect the IRS to take pity. The agency has already sued Coinbase, a cryptocurrency broker, for the records of traders who might not have reported their bitcoin gains.
» Read more: Tax evasion vs. tax avoidance: what’s the difference?
Bitcoin stolen? Tough
Bitcoin has suffered several high-profile thefts since it was established in 2010. Being robbed is bad enough, and previously if you’d been swindled of your bitcoins, you might have been able to deduct it as a theft loss on your taxes. However, the new tax rules do away with the deduction for personal theft losses.
Another tax rule doesn’t look favorable to owners of digital currency, either. The IRS allows owners to trade many kinds of property for a similar kind of property without immediately incurring a tax liability — it’s called a like-kind exchange.
Before the recent tax overhaul, owners of bitcoin wanted to know whether they could engage in like-kind transactions with other cryptocurrencies. “The answer was unclear,” Harris says. “What was unclear was whether one crypto was like-kind to another. Now the new tax reform has limited like-kind exchanges to real property, not personal goods.”
A bit of relief
While you must report taxable gains on any realized bitcoin transaction, the IRS also gives you a bit of relief and the potential for a tax break. You can deduct capital losses on bitcoin, just as you would for losses on stocks or bonds, and offset other gains on sale. When you’re done tallying your winners and losers, you can’t write off a loss of more than $3,000.
With the drastic fluctuation in bitcoin’s price in 2017 and 2018 — trading from less than $1,000 to nearly $20,000 and then back down to $8,000 — many bitcoin speculators will have losses. If you have losses on bitcoin or any other cryptocurrency, make sure you declare them on your tax return and see if you can reduce your tax liability.
A tax liability just for using bitcoin? It’s one more reason to be very careful with the cryptocurrency.