How to Pay Taxes on Bitcoin

Legal disclaimer: Always consult with a tax professional. This information is educational only. This is not legal advice.

It’s become increasingly simple over the past few years to purchase and sell bitcoin and other crypto currencies. With bitcoin’s major increase in popularity and price comes the question of taxes. There are a few simple points I would like to state as facts before continuing to dive in deeper.

  1. All bitcoin and crypto is taxable, no matter the amount.
  2. Taxes are only applied when the cash value is realized. Ex: Sold bitcoin, received cash.
  3. Bitcoin bought and sold for profit in under 1 years time is normal taxable income.
  4. Bitcoin bought and sold but was owned/held for over 1 year is taxed under capital gains.
  5. Bitcoin used to purchase goods & services is taxable as normal income when spent.

Federal government does not recognize bitcoin as currency. For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. At what sum total of cash do you need to claim taxes on bitcoin? All of it. The IRS states that even small income such as babysitting should be reported on your taxes. It’s safe to assuming every single dollar you profit on bitcoin is taxable.

It’s important to understand that you are only required to pay taxes on bitcoin when you turn it into cash. This obviously applies when selling your bitcoin at an online exchange or an ATM because you are receiving cash for your bitcoin. However, transactions made for purchasing goods or services is technically realizing a cash value for your bitcoin at the time you spend it. This means you’re required to pay taxes on the cash value of your purchase. This type of transaction is treated as normal income, not capital gains. So if you spend $100 worth of bitcoin to purchase something, you need to claim $100 of additional income on your taxes.

All bitcoin you purchase and hold for less than 1 years time and sold for profit is considered “short term gains” and is taxed as normal income. You will pay your full tax rate for a bitcoin investment under one year. This percentage depends on your normal tax bracket which is based on your income.

Bitcoin purchased and held for longer than 1 year is subject to capital gains tax instead of normal income tax rates. This means that you will be taxed 15% on the total profit from the selling of your bitcoin. If you buy $1000 worth of bitcoin and sell it for $2500, you have a $1500 capital gain which you will pay ~$225 in taxes on.

Be sure to keep your receipts for all your bitcoin transactions and purchases. If you are not sure what price you purchased your bitcoin at, you can always calculate the daily average price for bitcoin on that particular day. Be sure to reach out to a tax professional when possible.

 

Further reading and sources:

https://www.irs.gov/irb/2014-16_IRB#NOT-2014-21

https://www.irs.gov/newsroom/irs-virtual-currency-guidance

https://www.reddit.com/r/Bitcoin/comments/1uccfz/i_am_a_tax_attorney_here_are_my_answers_to_the/

https://www.investopedia.com/university/definitive-bitcoin-tax-guide-dont-let-irs-snow-you/

https://turbotax.intuit.com/tax-tips/tax-payments/tax-tips-for-bitcoin-and-virtual-currency/L1ZOgU00q

https://turbotax.intuit.com/tax-tips/investments-and-taxes/5-things-you-should-know-about-capital-gains-tax/L0m06D9lI