If you’ve traded Bitcoin or another cryptocurrency, you need to pay taxes. In this guide I’ll lay out everything you need to know about your cryptocurrency taxes this year.
This stuff is best understood with examples. Below I’ll lay out theoretical examples like: What happens if I purchase Bitcoin from USD and sell it 3 months later for a 25% profit? Then I’ll go over what would happen in that specific scenario. If there’s a scenario that you want me to cover, post in the comments and I’ll try to address it!
Disclaimer: this is not tax advice. You must consult a licensed tax professional regarding your personal tax situation. This article is simply based on what I’ve learned about cryptocurrency taxes. Any statements here should be confirmed with your tax advisor.
There are some essential things you need to know before I get into the tax scenarios. You can jump to any section that interests you.
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Who needs to pay taxes?
Companies like Coinbase are sending your trades to the IRS. Don’t think you can avoid taxes. Even if you aren’t based in the US, it’s likely that the tax authority in your country can find out about your cryptocurrency purchases.
Again, if you are buying and selling cryptocurrency, just pay your taxes. As I’m going to show you in this guide, it’s really not as difficult as it seems.
Is Bitcoin a Currency? And Why It Matters
As of now Bitcoin is treated as a property. That means that rules which govern property transactions, like buying/selling a house or car, apply to Bitcoin and other cryptocurrencies.
So Bitcoin isn’t a currency?
Correct. Bitcoin is a property. And that makes all the difference. Here’s how:
Imagine you are purchasing a computer on Amazon for $700.
You send Amazon $700 and they send you the computer. Amazon pays taxes on the profit of that sale. So if the computer costs them $550 to manufacture and send to you, they are left with $150 in profit. They need to pay tax on $150 in profit.
What happens if that sale is in Bitcoin instead of dollars (A property instead of a currency)?
Let’s say Amazon is selling the computer for 0.1 BTC.
You send them 0.1 BTC, they send you the computer.
If the computer cost them 0.085 BTC to manufacture and send, they are left with 0.015 BTC in profit.
How much does Amazon pay in tax on that profit?
This gets to the crux of how a property transaction differs from a currency transaction.
Amazon can’t just go to the IRS and say that they made 0.015 BTC in profit, and then pay 20% of that BTC come tax day. (I have no idea what Amazon’s tax rate is - 20% is completely made up.)
What Amazon needs to do in this case is calculate how much the Bitcoin was worth at the time of the purchase!!
In other words, what was the dollar value of Bitcoin when the computer was purchased?
If the 0.015 BTC in profit was worth $120 when the computer was purchased, then Amazon pays 20% of $120 to the IRS.
What if the price of 0.015 BTC drops to $50 by the time Amazon decides to convert the BTC to USD? They still need to pay 20% of $120 because that’s what BTC was worth at the time of the transaction.
On the other hand, if 0.015 BTC is worth $5000 when Amazon decides to convert it to USD for their tax bill, they will still only pay tax on $120 of profit.
The most responsible thing for Amazon to do in cases like this would be to immediately convert part of their BTC profits to USD and set it aside for their tax payments later on. That’s how they can avoid the volatility in BTC prices with regard to taxes.
Hopefully now you understand the difference between a currency transaction and a property transaction. We’ll see later on that buying a computer with Bitcoin is not unlike buying another cryptocurrency with Bitcoin.
What Percentage of My Profit Will I Pay in Tax?
I included this section because it is the question I get asked the most. Although I can’t tell you exactly how much you’ll pay in tax, I can give you some talking points that you can discuss with your accountant so you can better understand what you’re in for.
Although this is US-centric, I’ve found that many countries have similar rules.
Income tax is what you pay on ordinary income like a salary from a job or profit from selling something as the Amazon situation above describes.
The income tax rate varies wildly depending on how much income you actually earn. Again, you’ll need to consult your accountant regarding your tax rate.
Let’s see an example of an income-tax situation with Bitcoin.
If you buy 10 Bitcoin on March 1 for $70,000, and then sell it on March 20 for $80,000, you’ll pay income tax on the $10,000 in profit that you made.
But there’s another type of tax that could help you pay a lower rate than you would with income tax.
Capital Gains Tax
Capital Gains tax is a term to describe the tax rate you pay if you own an asset for more than a year. The rate is usually lower than what you’d pay in income tax.
The rate for capital gains tax in the US can be as low as 15%. Compared to income tax where you see rates usually above 30%, that’s a great deal!
Some countries don’t tax you at all for capital gains!
How does capital gains tax impact a Bitcoin purchase?
If you buy 10 Bitcoin on March 1, 2018 for 70,000 and sell it in under a year, you pay income tax. But if you hold the Bitcoin for more than a year, and sell it on March 2, 2019 for $100,000, you’ll pay the capital gains rate on the your $30,000 in profit instead of the income tax rate.
Bitcoin worth less than I bought it for
In this case you don’t pay taxes on the loss.
For example, if Bitcoin was worth $7,000 when you bought it, and $6,000 when you sold it, you aren’t going to be asked to pay tax because there was no profit.
Now you should have the foundational knowledge to understand how cryptocurrencies are treated in terms of taxes.
Below I’m going to go through several scenarios that a cryptocurrency trader might encounter.
If you have a question that I did not cover, feel free to ask it in the comments below.
Buy Bitcoin and sell it 3 months later for a 25% gain
You buy 1.5 BTC for $10,000, and three months later your 1.5 BTC is worth $12,500. You’re ready to sell it all to realize your profit. How much do you pay in tax?
Since you are only taxes on profit, let’s calculate that first.
Profit = SellPrice - InitialInvestment
In this case, Profit = $12,500 - $10,000
Which comes to $2,500 in profit.
That’s the amount that you’ll be taxed on, but which tax rate will you pay? In this case, since you only owned the Bitcoin for 3 months you’ll pay your normal income tax rate. If your income tax rate is 31%, then you’ll pay $775 in tax (2500*0.31=775).
You’re left with $1,725 to spend.
Buy Bitcoin and sell it 5 months later for a 12% loss
You buy 1.5 BTC for $10,000 and sell it 5 months later for $8,800.
Since your investment did not appreciate in value, you do not pay tax on the $8,800.
Use Bitcoin to purchase an Altcoin like Ethereum
Here’s where things get interesting.
Before 2018, people used to claim that buying one cryptocurrency with another cryptocurrency was a like-kind exchange. That would allow them to trade Bitcoin for Ethereum without paying tax between that transaction. They’d only pay tax once they realized their gains in dollars.
That’s no longer the case. Congress updated the tax code to clarify that cryptocurrencies should be treated as properties. Here’s a good discussion on why that means you can no longer classify crypto-crypto transactions as like-kind exchanges.
What you need to do is calculate the USD values of the Bitcoin and Ethereum at the time of the transaction.
If you purchase 1.5 BTC for $10,000, that’s your initial investment.
Later on, you decide to use that 1.5 BTC to purchase 20 ETH.
At the time of this transaction, your 1.5 BTC is worth $12,500. So you essentially are buying $12,500 worth of Ethereum.
A month later you decide to sell that 20 ETH for BTC. Because the price between BTC and ETH has changed, you sell the Ethereum and net 1.8 BTC. You have more Bitcoin than you started with! And that Bitcoin is worth $17,000.
That’s the taxable event. It doesn’t matter that you haven’t converted your earnings to dollars.
What you need to do is calculate how much profit you earned on that trade ($17,000 - $12,500 = $4,500) and then set aside enough USD to cover your tax bill for that profit.
If we use the 31% tax rate as we did above, you’ll need $1,395 for taxes.
You may be worrying about burden of tracking this stuff if you are making many trades every day. Don’t worry, there are servives that do it for you like Bitcoin.Tax.
Use Ethereum to purchase an Altcoin like BAT
You need to do exactly what we did in the example above. It doesn’t matter that Bitcoin isn’t part of this trade: all cryptocurrencies are treated as properties, so you need to calculate the dollar value at the time of the transactions.
Someone paid me for something in Bitcoin
If you were paid for a service in Bitcoin or another cryptocurrency, you need to pay income tax on the earnings. For example, if you designed a logo for someone and they paid you 2 BTC for your work, you need to calculate the USD value of 2 BTC at the time of the transaction and pay tax on that.
The thing to remember in a situation like this is that not setting aside the tax money immediately can come back to bite you later on. You have these 2 BTC worth $16,000, so let’s say you owe $4,960 in income tax (31%). But you don’t immediately sell some of the BTC to get $4,960. Instead, you hold it in hope that the value goes up.
This can get ugly.
By tax time the value of your 2 BTC has dropped in half (a common occurance in crypto-world). If you sell it now, you’ll be left with only $8,000. Does that mean your tax bill comes to 31% of $8,000?
You are taxes on the profit at the time of the transaction - you must still come up with $4,960.
The moral of the story is that you should immediately sell some of your Bitcoin to cover your taxes once you receive it.
I paid someone for something in Bitcoin
This is another question people have a hard time wrapping their heads around.
You might need to pay taxes if you pay someone in BTC.
Normally a business owner doesn’t pay taxes when they pay their employees in USD. But remember, Bitcoin isn’t a currency. It’s a property.
If you, as a business owner, bought 1.5 BTC for $10,000 and two months later pay a designer 1.5 BTC for a logo design, you need to calculate how much your BTC has appreciated in that time. If it’s worth $12,000, the IRS sees it like you just paid the designer $12,000, not 1.5 BTC.
But because your 1.5 BTC increased in value by $2,000 by the time you paid the designer, you are taxes on that profit - $620 if we use the 31% rate.
You don’t pay tax on the transaction if your Bitcoin is worth less than what you initially paid for it.
I'm making several trades every day. How do I track it all?
Tracking the dollar value of all of your transactions can be daunting, especially if you need to backtrack to trades you made months ago.
Fortunately, there are tools that will pull your trades from exchange APIs and do it all for you.
One such tool is Bitcoin.Tax. I haven’t used any other tools, but I’m sure you have several options.
Talk to your accountant. Pay your taxes.
It doesn’t have to be scary if you make yourself aware of the regulations and the tools to help you keep track of what you owe.