This past year, as historic gains in the cryptocurrency market grabbed headlines worldwide, droves of new investors purchased Bitcoin, Ripple and other top currencies en masse. And this year, there are many new potential investors still on the fence, waiting for the opportune moment to jump in. In the frenzy, new investors in the crypto space often forget to fully educate themselves on the tax implications of their newfound hobby. This can be a costly and even life-altering mistake.
As the 2017 tax deadline looms near, let’s take a look at some major considerations crypto investors should be aware of, whether they’re already in the market or planning to be in the near future.
Understanding the Basics
The first thing to note is that government regulations vary immensely from country to country, so Bitcoin and other digital assets might be taxed differently depending on your location. For the purposes of this article, we’ll be focused entirely on cryptocurrency in the United States.
In 2014, the Internal Revenue Service (IRS) issued its landmark Notice 2014-21, which stated that virtual currency is to be treated as personal property for U.S. federal tax purposes, and that general rules for property transactions apply. And so, right then and there, countless dreams of under-the-table crypto windfalls were dashed. But, what impact are these virtual currency rules and regulations having now that cryptocurrency has gone mainstream?
Combatting Crypto Tax Confusion
2017 was a banner year for the cryptocurrency market, as the ten best-performing coins achieved an average 14,000 percent increase in price, according to data from CoinMarketCap. Hundreds of thousands of new investors joined exchanges each day, many no doubt chasing extraordinary gains out of FOMO. But, it seems that the vast majority of cryptocurrency investors either don’t know or don’t care that the IRS is also chasing those gains – at least a percentage of them.
According to a recent report from Credit Karma, less than 0.04 percent of tax payers who had filed their returns by February of 2018 reported any kind of cryptocurrency transactions in 2017. With crypto investing’s meteoric rise in popularity throughout 2017, it stands to reason that more people than this would have a reason to report their cryptocurrency activities. It’s hard to believe that so many Americans would willingly face strict IRS retribution by trying to fly under the radar with their crypto gains, so it might make more sense that many who invest in digital assets are uniformed, confused or both.
According to IRS regulations, here are several major tax considerations every crypto investor should be aware of:
- Trading: Cryptocurrency trades (when you exchange one token for another) that result in capital gains should be reported on your taxes. For example, let’s say you purchase Bitcoin at $50,000 and it appreciates in value to $60,000. If you were then to trade your $60,000 of Bitcoin into Ripple, you must report $10,000 in capital gains. On the other hand, trades that produce losses are actually able to counterbalance gains and reduce over taxes.
- Short-term vs. Long-term Ownership: If you’ve owned a digital asset for more than a year, any gains made on it would be considered “long-term” capital gains. If you sell or trade your digital assets frequently – only holding for a year or less – you’re subject to “short-term” capital gains. Short-term capital gains are taxed at a much higher rate than long-term gains.
- Using Crypto for Purchases: Spending cryptocurrencies to purchase goods or services is a taxable event, which may also bring about capital gains or losses that need to be reported on your taxes.
- Receiving Crypto Payments: If you choose to receive your salary in the form of a certain cryptocurrency, or if you sell products or services in exchange for crypto, these earnings are taxed as ordinary income based on the value of the coin at the time of each transaction.
- Cashing Out: Liquidating your cryptocurrency holdings to “cash out” is a taxable event and should be reported on your taxes.
And these are just to name a few. There are other tax considerations involving cryptocurrency mining, subtle strategies for calculating capital gains and losses for a more favorable outcome, etc. With so many tax issues to keep in mind and such steep penalties for tax evasion (even if unintentional), investors can’t afford to take chances. One thing’s for sure: any cryptocurrency investor who feels even the slightest bit uncertain or confused about their tax obligations should speak with licensed CPA sooner rather than later.
A Tax-Friendly Crypto Investment Option
For those looking to shelter themselves from the hassle and confusion caused by the tax implications of traditional crypto transactions, Digital Currency IRAs can be a safe haven. The IRS characterized digital currencies as personal property for tax purposes, thus making them eligible to be held inside an IRA. This long-term investment tool allows investors’ digital currency gains to remain tax-free until they’re withdrawn from the retirement account as a distribution.
And, if Digital Currency IRA owners sell their coins within an IRA without taking a distribution, any resulting gains can be reinvested in other asset classes. In other words, these types of IRAs don’t need to remain entirely in digital assets to keep their tax-deferred designation. For example: If you buy two Bitcoin inside your IRA account and sell them later for a profit, you can reinvest your capital into any IRA-approved asset (such as stocks, bonds, mutual funds, ETFs, precious metals, private equity, certain types of real estate, and more) while still enjoying full tax-deferred benefits.
Crypto Taxes Aren’t Going Anywhere
As the cryptocurrency market continues to grow and evolve, so will regulatory requirements put forth by world governments. It’s clear that the IRS is working tirelessly to get a handle on this new and exciting market, and they won’t be stopping anytime soon. Whether you’ve been in the crypto market for the past year or you’re planning to make an entrance in 2018, read up on the tax implications and requirements that cryptocurrency investments carry to make sure you’re clear about your responsibilities. With so many complex tax considerations involved with traditional cryptocurrency investments, more and more people are considering Digital Currency IRAs as a safe, secure and tax-friendly route.
***Disclaimer – none of the above should be considered financial advice.