Bitcoin Tax Accounting

Introduction

As with any other asset, accurate and timely tax accounting with bitcoin is important for avoiding unnecessary penalties and forfeitures. Bitcoin taxes can be intimidating, but are no more complicated than traditional asset taxes. Prior to tax season, you should begin collecting the necessary information for filing taxes associated with bitcoin. The amount and type of tax your bitcoin will be subject to during each tax period, as well as how the taxes should be reported to the IRS, depends on the value of your bitcoin, how much you have bought, sold, or earned, as well as your mining activity.

How Does the IRS View Bitcoin?

A dangerous assumption made about bitcoin is that it is untraceable, and therefore nontaxable. This is untrue; the IRS takes proper tax reporting, especially on bitcoin, very seriously. Confusion can arise about filing taxes associated with bitcoin because it is often referred to as a currency. However, the IRS does not view bitcoin as a currency. As of 2014, the IRS treats bitcoin as property, per IRS Notice 2014-21. Therefore, tax principles that apply to property transactions also apply to Bitcoin transactions and earnings, including any losses or gains made in transaction. Because bitcoin is not treated as a currency, it does not generate foreign currency gain or loss taxes. Bitcoin taxes are calculated at a fair value based on the payment or reception date, in U.S. dollars.

➤ Learn more about IRS Notice 2014-21.

Taxes From Selling Bitcoin

Buying and holding bitcoin will not create a taxable event, but selling bitcoin for a profit incurs a tax on the profit, known as a capital gains tax. Capital gains taxes only occur when bitcoin is sold.

For example, if Alice bought 1 bitcoin for $4,000, and sold it one year later for $35,000. The $31,000 profit is considered a capital gain, and the sale is a taxable event. Regardless of whether Alice sells bitcoin for U.S. dollars or other cryptocurrencies, the capital gains tax and how they are calculated does not change. There are two types of capital gains taxes: short-term and long-term.

• Short-Term Capital Gains. A tax on the profits from selling bitcoin for USD or other cryptocurrencies within 12 months of the original purchase date. Short-term capital gains are taxed at your standard income tax rate.
• Long-Term Capital Gains. A tax on the profits from selling bitcoin for USD or other cryptocurrencies after holding it for more than 12 months. Long-term capital gains are taxed at variable rates ranging from 0% to 20%, based on your standard income tax rate.

Correctly assessing capital gains taxes requires calculating your cost basis and fair market value. Your cost basis is the purchase price of all bitcoin holdings, including any fees, divided by the total quantity of bitcoin. Capital gains taxes are assessed as the difference between your cost basis and the fair market value, which is the dollar value that you sold your bitcoin for.

Taxes From Earning, Mining, or Staking Bitcoin

Selling bitcoin is not the only way taxable events occur. Bitcoin earned as compensation for goods and services, interest, staking, or mining will be taxed at your standard income tax rate. The amount owed in income tax is based on the value of the bitcoin on the date that you received it. The value of the bitcoin on the date you received it is known as the fair market value, and is used to determine your taxable income. Less common events, including airdrops and hard forks, will also generate a taxable event at your standard income tax rate.

Bitcoin Tax Forms

Earning and selling bitcoin generate distinct taxable events, so the forms and manner in which earnings and capital gains are reported to the IRS are different. Below are some of the most common forms used to report bitcoin earnings and capital gains:

• Form 8949. IRS Form 8949 is used to report all bitcoin transactions, including dates, cost basis, and any gains or losses. The total value of all trades should be calculated on Form 8949 and reported on your 1040 Schedule D.
• Form 1040 Schedule D. This form is a subset of Income Tax Form 1040, and is used to report capital gains and losses.
• Form 1099. 1099 forms are used to report self-employment income, interest, and dividends. If you earned bitcoin through mining or interest, this form would be used to document the income earned from those activities.
• Form 1099-B. If you are buying and selling bitcoin with a brokerage, your brokerage will provide a 1099-B form that details your net short-term and long-term capital gains and losses.