Monday, January 29, 2018

How to deal with cryptocurrency investments in your 2018 tax filings

More than in any other year to date, 2017 saw the Federal government get involved in the cryptocurrency industry, and in particular who among Americans might be trading them as an investment.  In fact last year the IRS attached their hooks into the U.S.'s largest cryptocurrency exchange in order to track transactions which could lead them to going after traders who fail to report their profits and losses in their tax filings.

So with this in mind it is crucial for crypto investors to be even more diligent than ever since cryptocurrency exchanges rarely provide statements documenting one's trades.  And this means you alone are responsible for not only that documentation, but for also reporting your windfall accordingly under the category of capital gains.

It’s been a turbulent year for bitcoin, and now it’s time to talk about taxes. Most people who held on to bitcoin over the past year made money off of it, and as Americans prepare for income tax season, the IRS wants its cut of the profits. Amid unprecedented gains — and unprecedented enforcement efforts — this looks to be the year that tax collectors get serious about bitcoin earnings, which means it’s a very good time to make sure you’re doing everything right. 
So let’s get into what you’re reporting and how to report it. To simplify things, we’re only talking about bitcoin here, but note that these general guidelines apply to other cryptocurrencies as well. Also, none of this is legal advice, so if you have specific questions, it’s best to consult with a tax lawyer or accountant. 
1.      DO YOUR BEST TO DOCUMENT EVERYTHING 
First, you’ll want to download all transaction data from the exchanges you use, usually available as CSV files, suggests Vincenzo Villamena, managing partner at Online Taxman, an accounting firm that specializes in cryptocurrency. Some exchanges, like Coinbase, will send certain US users form 1099-K if they have received “at least $20,000 cash for sales of cryptocurrency related to at least 200 transactions in a calendar year.” If you don’t use an exchange, just do your best to document everything. 
There is also software that can help with doing bitcoin taxes, such as Bitcoin.Tax and CoinTracking.Info. Bitcoin.Tax lets you upload CSV files from exchanges, and it’s free for up to 100 transactions. CoinTracking.Info does the same, and it’s free for up to 200 transactions. (As pointed out by Forbes, which reviewed both software, the programs let you cherry-pick which accounting method you’d report by after the year has ended. Some of the methods may not be IRS compliant.) 
2.       WHERE TO REPORT BITCOIN INCOME 
Most people will have income from buying bitcoin and then selling it at a higher price. If that’s true for you, then any income from the sales needs to be reported on Schedule D, an attachment to Form 1040. 
How you report the sales will depend on how long ago you bought your bitcoin. If you’ve held the bitcoin less than a year before transacting with it, it’s taxed as a short-term capital gain, which is still taxed at the same rate as ordinary income. But if you’ve held bitcoin longer than a year before using it, bitcoin is taxed as a long-term capital gain at lower rates of anywhere from 0 to 20 percent, also depending on what income bracket you fall under. If you’re in the top three highest income brackets, you also have to pay a 3.8 percent tax on net investment income. (It’s also worth noting that while not being taxed as ordinary income, capital gains may increase your overall adjusted gross income, which could impact which tax bracket you ultimately fall under.) 
3.      HOW BITCOIN IS TAXED 
Method obtained
Duration held
How to report
Additional taxes
Received for services
N/A
Ordinary income
State income tax
Bought for investment
Less than a year
Ordinary income
State income tax
Bought for investment
More than a year
Capital gain
3.8 percent for top three tax brackets
Mined
N/A
Ordinary income
Self-employment tax if applicable
Bitcoin fork
N/A
Ordinary income
TBA

Things get more interesting if you were mining your own bitcoin. Any bitcoin gained through mining is taxed as ordinary income, based on the “fair market value” of the bitcoin at the date it was received. (Again, you can look up the historical price of bitcoin here.) Additionally, if the mining counts as a trade or business transaction, and the taxpayer isn’t doing it for an employer but for themselves, they have to pay the self-employment tax, which is 15.3 percent on the first $127,200 of net income and 2.9 percent on any income in excess of $128,400. 
If you were paid for goods or services in bitcoin, it gets taxed as ordinary income. (It technically is income, just in a different currency.) Depending on your income bracket for 2017, the federal tax rate can be anywhere from 10 percent to 39.6 percent. The bitcoin will also be subject to state income tax. 
If your bitcoin account is held abroad where the private keys are owned directly by the exchange, you get double the fun: the value of the account has to be reported to the US Treasury using FinCen form 114, and to the IRS with the form 8938. US residents and citizens who own less than $10,000 of assets abroad don’t have to report.
If you have any other questions, you can look to the guidance on virtual currencies released by the IRS in 2014. It’s a few years old, but it’s still the IRS’s best guidance on the issue, and the agency referred 
4.      OTHER NEW CHANGES 
The Republican tax reform bill that passed in December not only shifted around tax income brackets, but it also cut out a bitcoin investor loophole. This will only take effect when filing 2018 taxes in 2019. The bill eliminated an exemption where bitcoin investors switching over to Ethereum, litecoin, or other altcoins could defer paying taxes on the original bitcoin. This was known as a “like kind exchange,” also known as a 1031 exchange. In 2018 tax returns, that exemption will only apply to “real property,” meaning real estate. 
5.      WAYS TO MINIMIZE BITCOIN TAXES 
You can donate cryptocurrency to charities but you must donate directly to the charity, as selling it first would be taxable. While charities like Goodwill may not accept bitcoin, you can still donate to causes like The Water ProjectWikileaks, and the Internet Archive to name a few. Robert Wood, a tax lawyer who’s written on cryptocurrency taxes for Coin Telegraph, says, donating bitcoin to charity “can be a smart move, generating a tax deduction for the market value, without having to pay tax on the appreciation.”
You can also hold on to the bitcoin long-term, disregarding the downturn in bitcoin prices recently and any desire to cash out early, in order to defer taxation, Villamena suggests. – The Verge

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