In the first part of this series we looked at how calculating capital gains for Bitcoin gets complicated very quickly.
There are a few more specific areas that should be understood and might be relevant when filing taxes.
Selling or spending Bitcoins at a lower price than you acquired them is a capital loss.
When you make a profit, a capital gain, you have to pay taxes on that difference. But when you make a loss you can reduce your overall taxes.
This is done in two ways. First, any losses made during the year can be used to reduce any other gains you may have made. For example, you may have gains from the stock market that are also included in Schedule D of your 1040. Adding your gains and losses will reduce your total gains and so reduce the amount of taxes you will pay.
You need to be aware that first, you combine your long-term gains and losses, then short-term gains and losses, and finally arrive at your net gain or loss.
If you have a net loss once all your other gains have been reduced to zero, then that loss can be used to reduce your ordinary taxable income, however, only up to $3,000 per tax year. Any remaining losses can be carried forward into future years.
At the tax end year, you might think to sell stocks that have fallen in price, buy them back, just to create a loss and report it in your taxes. You'll have capital losses, pay less taxes and could buy those stocks back again at a very similar price.
This is known as tax-loss selling and the IRS prevents it by their wash sale rule. A sale is deemed to be a wash if you buy the same, or similar, stock or security within 30 days before or after a loss sale. If a sale is a wash, then you cannot claim those losses but instead they are transferred to the cost basis of the related purchase.
The tax code defines wash sales as only applying to stocks and securities, which Bitcoin is neither:
A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale [IRS p17]
That's not to say they should be allowed, but since Bitcoins are property they do not fall under this rule.
However, there is more to it than this, something called the "economic substance doctrine". This says that a transaction must have economic substance apart from just tax effects. Clearly selling and immediately re-buying the same coin at the same price has no economic substance other than generating a tax loss, and so those losses could be deemed invalid.
To avoid this you would have to do something that does have economic substance, such as buying different assets or waiting enough time that you are exposed to risk. How long should you wait? As noted by tax attorney Tyson Cross, there is no clear answer but it is days and possibly up to a week.
Something still unknown to many users is that spending and selling Bitcoins are treated the same for tax purposes. This was clarified by the IRS in March 2014 in that a disposition of Bitcoins, i.e. property, is a tax event. You must therefore calculate any potential capital gains.
This is different than how foreign currency is treated, where you are allowed up to $200 gains before any gains must be reported. But this is a consequence of the IRS treating Bitcoins as property rather than currency.
Using the well-known "cup of coffee" example, if you buy a latte for $5 with Bitcoin, you have a burden to work out any gains. While the amount of gains could be negligible or even zero due to rounding, you don't know this until you check. Say you bought some Bitcoins in January 2013 at a price of $10, then bought your coffee in January when the price was $800, you just bought a $5 drink for $0.06. That difference of $4.94 is capital gains.
(0.00625 BTC x $800) - (0.00625 BTC x $10) = $4.94
Whereas, if you had bought those Bitcoins at $750, your gain is only $0.31. This is rounded to zero, as gains are always reported to the nearest dollar so there is nothing to report.
(0.00625 BTC x $800) - (0.00625 BTC x $750) = $0.31
You should always keep a track of all your spending, the date, amount of Bitcoins and dollar value, so you can check if there was any gains.
Having your salary paid, or partially paid, in Bitcoin has become more popular over the last couple of years but you do still need to be aware of any tax implications.
It seems that for most of these situations employees are simply receiving some or all of their existing salary in Bitcoin. In this case the earned dollars, and therefore taxes, haven't changed. Instead of receiving dollars into your bank account, you are receiving Bitcoins into your wallet. The employer will still report your income in dollars, with the same amount of withholding, social security and Medicare taxes.
The only difference here is that those Bitcoins have their cost basis set as the date of receipt and at their fair value. This is the amount, or portion, you would have been paid in dollars into your bank.
For example, you normally receive a net deposit of $2,500 each pay period but you have opted to have 20% paid in Bitcoin. You would now receive $2,000 into your bank as normal and then, say, 1 BTC into your wallet. The cost basis of that Bitcoin is $2500 - $2000 = $500, which you should record for when you come to sell or spend it.
If you were working independently and paid in Bitcoins, similar rules apply. You still received income and must convert it into dollars for your taxes. The amount is the fair value, which is value of your goods/services. For example, say you provided a service normally worth $100 but instead received Bitcoin in payment, then you would report $100 income. If you can't give a fair value for the goods/services, then you would need to use the market price of Bitcoin to calculate the dollar income amount.
Another clarification in the IRS's March notice was how mining should be treated. Mining is income, on the day of receipt of any coins and at the fair value of those coins. This means that if you mined any Bitcoins or alt-coins either solo, as part of a pool, or through a cloud provider, you need to report any coins you received as income.
Where it is less clear, is what that dollar value might be, since the fair value is not always as easy to determine.
Bitcoins, Litecoins, Dogecoins, are all examples of where there is a direct USD market and so you can easily find out their value of any given day. However, a newly created alt-coin that was mined in its early days has no direct market and so how do you determine its value? Or for any alt-coin, e.g. ABC coin, that has no direct USD market but does have a BTC market. Does it have a value? Do you have to make a conversion from ABC to BTC to USD?
Since there is no clarification yet from the IRS on this issue you should discuss how to proceed with your own tax professional. BitcoinTaxes has taken a prudent approach and calculates value where a fiat or BTC market exists, converting an alt-coin to BTC to USD as necessary.
Filling in the 1040
Income from Bitcoins and all crypto-currencies is declared as either capital gains income or ordinary income, for example from mining.
Ordinary income will be declared on either your 1040 (line 21 - Other Income) for an individual, or within your Schedule C, if you are self-employed or have sole-proprietor business.
Capital gains income, or losses, are declared on Schedule D. Since there are no reported 1099 forms from Bitcoin exchanges, you will need to include your totals with Box C checked for short-term gains, and with Box F checked for long-term gains.
These totals are calculated from Form 8949 that has details of each of your transactions. Each includes:
- Description of the asset
- Acquisition date
- Sale date
- Acquisition cost
- Sale proceeds
- (No adjustments as wash sales are not applicable)
- Gain or loss
Fill in your short-term trades in Part 1, checking Box C, and your long-term trades in Part 2, checking Box F.
The totals are then put onto Schedule D.
BitcoinTaxes can create the files needed for importing into TurboTax or TaxACT.
Unfortunately, TurboTax currently does not provide the import facility within their online version and instead you must use their CD/Downloadable version, but it is limited to only 500 transactions. TaxACT does provides importing directly into their online version up to 2,000 transactions.
If you need to import more, you can create a summary statement on a Form 8949 and print off separate sheets that include the same details but in a more compact format. See Form 8949 instructions for more details.
If you use a CPA or tax preparer, you should see what format they require, but likely a spreadsheet of the same data as on the 8949 above will be sufficient.
Everything here is for information purposes only and is not, and cannot substitute for, tax or legal advice. As always, please consult with your tax professional, CPA or tax attorney for advice and on how to file your taxes correctly.
More tax professionals are becoming knowledgeable of Bitcoin, but if you have questions, looking for advice, or looking for Bitcoin tax preparation services, you can get in touch with Tyson Cross, Bitcoin Tax Solutions, a tax attorney with knowledge and experience in Bitcoin tax issues.
Filing taxes with Bitcoin is not in itself difficult, however, can become overwhelming with an increased usage or volumes of transactions.
The third part of this series shows you how you can use BitcoinTaxes to calculate your capital gains, mining income and estimated tax liabilities. You are then ready to include this in your 1040, Schedule D and Form 8949.