Cryptocurrency has become an incredibly exciting investment form that allows investors to build wealth in a unique way. As an investor, you may already be excited by the advantages that come with cryptocurrency. Unfortunately, many aren’t sure how to manage capital gains taxes on their investments.
Do you know how to report capital gains tax for cryptocurrency, or have you found yourself worrying about potential income tax implications? Understanding how to properly report your capital gains can mean the difference between worry-free earnings and a stressful — and potentially costly — IRS audit.
What Is Cryptocurrency?
Cryptocurrency is a digital asset. It is secured by cryptography, which makes it much more difficult to counterfeit or double-spend than other forms of currency, and is not issued by a central governing authority.
The first type of cryptocurrency to catch attention was bitcoin, but there are multiple forms available. The asset is typically purchased or obtained through “mining,” which sees coinbase miners rewarded with digital currency for completing “blocks” of verified transactions using high-powered computers with specialized software. Miners may also receive high-level rewards for working through specific problems and challenges before anyone else.
Understanding Capital Gains Taxes on Cryptocurrencies
A capital gains tax is a tax on the income you receive from selling items that are not inventory in stores or businesses. Bitcoin, ethereum and other cryptocurrencies serve as digital assets for tax purposes, according to the Internal Revenue Service (IRS). That means you will need to consider cryptocurrency as you would stocks — something that you can sell and trade — when you file your taxes every year, and will need to report your profits and losses just as you would other investments.
This includes when:
- Trading cryptocurrency for actual currency
- Trading one type of cryptocurrency for another
- Using cryptocurrency to make a purchase
- Earning cryptocurrency as income
You will need to assess the cash value of a cryptocurrency transaction in U.S. dollars to calculate the taxable amount, then determine the tax rate for that transaction alongside your other income. You should thus carefully track any cryptocurrency purchases or transfers to more easily assess your taxable income. A trusted tax advisor can help you better understand how to calculate the value of your funds and exchange rates.
How to Report Capital Gains Tax
When you start to fill out your taxes (as of 2019), you will notice that the IRS asks whether you have had any dealings in cryptocurrency over the previous tax year. Those rules have been in place since 2014, but the IRS is now paying more attention to those transactions. As such, you want to make sure you report them correctly. Here are a few tips about the process.
1. Pay Attention to Your Gains and Report Them Accurately
Start with a solid understanding of how much you actually gained from each transaction. That will mean converting the value of your cryptocurrency to actual dollars as well as calculating the actual profit from the transaction at the purchase price. For example, if you gained $5,000 in a transaction, but spent $300 in the process, your net gain would be $4,700, not $5,000.
2. Monitor Tax-Deductible Expenses
You can deduct the cost of many of the expenses associated with your investments from your taxes, including exchange fees, trading fees, and your losses. Discuss these expenses with your tax consultant for a better idea of how to include them in your tax reporting. Those tax-deductible expenses can also help offset any losses during your investments.
3. Fill Out Your Tax Forms Properly
You will need to fill out Form 8949 and Form 1040 Schedule D to note your capital gains from cryptocurrency transactions. Form 8949 deals with the disposition of capital assets, and you can use it to calculate your gains as well as losses during a taxable event.
The Benefits of Working With a Trusted Tax Advisor
Work with a trusted tax advisor will put you in a better position to correctly calculate your gains from cryptocurrency investments and ensure you do not miss anything as you fill out your forms. The IRS is cracking down on proper reporting, making it more important than ever to ensure you track your gains and losses at a fair market value and report them as accurately as possible.
Working with a tax advisor could help you avoid an audit or costly fees, too, as the IRS is currently issuing a reward for those who report crypto tax fraud — and you don’t want to get caught in their net!
Contact the Tax Experts
Whether you have already invested in digital currency and want to be sure you report your investments properly or are considering investing in it in the future, a tax advisor can help ensure that you don’t miss any important details. Contact Silver Tax Group today to discuss your crypto tax and long- or short-term capital gains questions, or to speak with a tax professional about other tax law questions you might have.