More than a decade after its launch, there is still substantial uncertainty concerning Bitcoin’s taxation. The cryptocurrency was designed to be a medium for everyday transactions, but it has failed to garner economic momentum. Meanwhile, it has grown popular with speculators and traders looking to profit from its volatility.
In its notice 2014-21, the Internal Revenue Service examined bitcoin transactions. The agency declared that cryptocurrency will be viewed similarly to property as an asset. The IRS started introducing a question on Form 1040 in 2019 to ascertain whether the taxpayer had any bitcoin transactions during the tax year.
Assets are subject to numerous types of taxes depending on the kind of transaction. However, due to Bitcoin’s unique qualities and use cases, there are some exceptions.
- The IRS has classed Bitcoin as an asset equivalent to property and taxes it accordingly.
- Bitcoin transactions must be reported to the IRS by US taxpayers.
- Retail Bitcoin transactions, such as the purchase or sale of products, are subject to capital gains tax.
- Bitcoin mining companies must pay capital gains tax and may claim business deductions for their equipment.
- Bitcoin hard forks and airdrops are taxed at the same rates as regular income.
- Bitcoin transactions are subject to the same restrictions as cash or property transfers.
Bitcoins & Taxation Frequently Asked Questions
Bitcoin is currently traded on exchanges and is linked with major foreign currencies such as the US dollar and the euro. The United States Treasury recognized bitcoin’s rising relevance when it stated that bitcoin-related transactions and investments are not prohibited.
Here are some answers to frequently asked questions concerning Bitcoin taxation.
Do you have to pay taxes on Bitcoin transactions?
That inquiry has a simple answer: yes. The fact that Bitcoin is classified as an asset clarifies its tax consequences. The IRS has made it necessary for taxpayers to record all bitcoin transactions, no matter how minor. Every US taxpayer is expected to maintain a record of all Bitcoin purchases, sales, investments, and use. In July 2019, the IRS sent warning letters to over 10,000 taxpayers it suspected of “possibly failing to declare income and pay the resultant tax from virtual currency transactions or failing to disclose their transactions correctly.” It cautioned that failing to declare revenue correctly might result in fines, interest, or even criminal prosecution.
Which types of Bitcoin transactions are taxed?
The following Bitcoin transactions are subject to taxation:
- Bitcoins mined privately and sold to a third party.
For example, if you mine a Bitcoin and subsequently sell it for a profit to another person, you must pay capital gains taxes on the transaction.
- Purchased Bitcoins are sold to a third party.
For example, if you buy Bitcoin via a cryptocurrency exchange or from someone else and then sell it for a profit, you must pay capital gains taxes on the transaction.
- Purchasing products or services using mined Bitcoins.
For instance, if you buy coffee using Bitcoin that you mined at home, you must pay taxes on the transaction. (The amount of taxes depends on the transaction’s circumstances, such as the value of Bitcoin at the time of sale and the price of coffee.)
- Using Bitcoin purchased from someone to purchase goods and services
For example, if you take Bitcoin from an exchange and use it to buy things, you will be subject to capital gains taxes.
The first and third possibilities are taxed as personal or corporate income after deducting mining-related expenditures. The second and fourth situations are more akin to asset investments.
Assume you bought a Bitcoin for $200 and sold it for $300, or utilized an equal amount in commodities. The $100 profit from the sale is subject to capital gains tax.
Do I have to pay taxes if I receive cryptocurrencies as payment for goods and services?
Salaries or payments received in cryptocurrency are taxed as conventional income. The cryptocurrency’s value or cost basis is its price on the day it was utilized for salary payment.
Do I have to pay taxes if I am a Bitcoin miner?
Yes. Mining for cryptocurrency is a taxable event. The coin’s fair market value or cost basis is its price at the moment you mined it. The good news is that you may claim business deductions for mining equipment and materials. The nature of such deductions varies depending on whether you mined cryptocurrency for personal or individual benefit. If you operate a mining company, you may use deductions to lower your tax burden. These deductions, however, are not allowable if you mined the cryptocurrency for personal gain.
Do I have to pay taxes when I convert from one cryptocurrency to another?
Some have suggested that converting one cryptocurrency to another, such as Bitcoin to Ether, should be treated as a like-kind transfer under Internal Revenue Code Section 1031. The IRS permits you to postpone paying income taxes on such transactions. During the early days of crypto trading, many crypto investors took use of this opportunity to delay their revenue from bitcoin transactions. However, the IRS declared on June 18, 2021 in a Memorandum from the Office of Chief Counsel that such transfers do not qualify as a like-kind exchange under Section 1031. Furthermore, the Tax Cuts and Jobs Act (TCJA) of 2017 made it clear that like-kind transfers are limited to property transactions.
What are the tax implications when a blockchain undergoes a hard fork or cryptocurrencies are dropped?
A cryptocurrency hard fork happens when the blockchain splits, implying a change in protocols. A new currency is formed, having changes in mining and use cases from its predecessor. The original cryptocurrency’s holders may be awarded new coins. This approach is also known as an airdrop, and it is utilized as a marketing tool by new currency producers to increase demand and use.
There were previously various doubts about the tax consequences of hard forks and airdrops. Should they, for example, be classified as stock splits or dividends? Is an airdrop income tax-free?
The IRS confirmed in a 2019 judgement that hard forks do not result in gross revenue if the wallet holder does not get bitcoin units. Airdrops, on the other hand, qualify as gross income when the holder gets units of a new cryptocurrency as a result of a hard fork or from coin marketers. In the second situation, the tax amount is determined by the quantity and time at which a crypto wallet holder gets the additional coins. Airdrops are subject to ordinary income taxation.
What are the tax implications of donating, gifting, or inheriting cryptocurrencies?
Contributions in cryptocurrency are considered similarly to monetary donations. They are not taxable. Based on the coin’s market price at the time, an appraiser will determine its fair market worth. The donor is exempt from paying taxes on the price gain. Cryptocurrency gifts of less than $15,000 are not taxable. If the receiver of a crypto present worth more than $15,000 chooses to sell the gift, their cost basis stays the same as the donor’s. Inherited crypto assets are regarded the same as regular assets, which means they are subject to the same estate restrictions.
What are some special considerations for cryptocurrency taxes?
Bitcoin taxation and reporting are more complicated than they seem. For starters, the volatility of the bitcoin price makes determining the fair value of the cryptocurrency on buy and sell transactions challenging. It is also challenging to determine the best accounting system to utilize for bitcoin taxes. Last In, First Out (LIFO) and Highest In, First Out (HIFO) have the potential to reduce taxes, but the IRS has allowed just a handful cases of its usage by cryptocurrency dealers. The most generally utilized technique for bitcoin accounting is first in, first out.
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