Bitcoin & Cryptocurrency Tax: The What, How, and Why
Bitcoin (BTC), the world’s first cryptocurrency, is only 11 years old. Compared to the other currencies we’re used to seeing like USD or JPY, Bitcoin is a baby—meaning that the thousands of cryptos that followed BTC are even younger. As a result of their general newness to our financial realm, many regulators are still trying to figure out how to tax crypto. Because of that, not many people really know how to pay Bitcoin tax.
As we continue to navigate through Bitcoin’s journey as a full-fledged currency, let’s take a look at how some places are paving the way for fair crypto regulations.
Figuring it out as we go
With growing worldwide cryptocurrency adoption, a few countries have figured out how to implement cryptocurrency tax laws. Most countries, like the US, treat and tax cryptocurrencies like property.
As a result, the profits you make from investing or trading will be treated as capital gains. On the other side of the spectrum, if your crypto depreciates over time, you could possibly deduct the losses against your other capital gains and reduce your taxes. In this case, the amount of crypto tax you pay will depend on how much you’ve gained or lost. You’ll also need to note the date, cost bases, sale value, and any fees charged along with the transaction. We’ll get more into these aspects later.
Taxable events to take note of
When you deal with cryptocurrency, it’s important to know which of your transactions are taxable and those that aren’t. Generally speaking, here are the events that can be considered taxable:
- Selling crypto for fiat currencies like USD, CAD, EUR, JPY, etc.
- Trading crypto for other cryptos (i.e., BTC for ETH—cryptos don’t need to be cashed out to fiat to be taxable)
- Using your crypto to buy a good or service
- Receiving crypto from mining or as a result of a fork
On the other hand, these events are generally considered nontaxable:
- Buying crypto with fiat (except in cases where the coin’s purchase price is lower than the fair market value)
- Donating crypto to a tax-exempt organization or charity
- Gifting crypto to another person (unless it’s large enough to trigger the gift tax)
- Transferring your crypto into another wallet that you own
How to file your taxes
The process of filing your crypto taxes will obviously vary depending on where you are in the world, but generally, there are two steps for filing them. First, you have to determine your cost basis. A cost basis is how much money you used to buy your property—or in this case, crypto. This includes all the fees that are charged with the crypto purchase. Here’s what the equation would look like:
(purchase price of crypto + other fees)/quantity of holding = cost basis
From there, you’ll then have to deduct the cost basis from the fair market value. Basically, fair market value is how much an asset would go for in the open market. Sometimes, it’s referred to as the sale price of an asset. Your equation then becomes:
fair market value – cost basis = capital gain/loss
Now, let’s use an example to give you a better idea of how this works. Let’s set the scene: it’s November 2017 and you’re looking to buy Litecoin (LTC). You decide to invest 500 USD, which would have bought you around 5.1 LTC. Let’s say that your exchange also charged you a 1.49% transaction fee. This is how your cost basis would be calculated:
(500 USD + 1.49%*500)/5.1 = 99.50 USD per LTC
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A month has passed and Litecoin has doubled its price to 200 USD per LTC. You decide to sell 1 LTC. Since you’re selling your crypto for fiat, it becomes a taxable event. To do so, you’ll need to know your capital gain:
200 USD – 99.5 USD = 100.5 USD capital gain
As a result, you’ll then owe a crypto tax from the 100.50 USD gained to the government on your taxes.
Next, if you’re from the US, you’ll need IRS form 8949 and 1040 Schedule D. On those forms, you’ll need to list each and every trade you’ve made (as well as the date, proceeds, cost basis, and gains/losses), total them up, and include them in your yearly tax return.
Why crypto taxation matters
The original purpose of cryptocurrency was to create a digital currency without borders—a currency that doesn’t live in the shadow of government control. But let’s be real, at this point, we should know that the idea isn’t realistic.
Despite crypto living in its own decentralized space, we, human beings, live in countries with crypto laws that we need to follow. Governments need their citizens to pay taxes so that they have the budget to make their country better.
If you hold cryptocurrency, you have to do your part in being aware of the cryptocurrency tax laws in your home country. If you don’t, you could face some severe penalties that include fees, interest, audits, confiscated refunds, and even jail time.
Here’s an example of how not doing your Bitcoin taxes could hurt your wallet: let’s say that you bought 10 BTC at a rate of 3,000 USD each. As time passes, the price balloons to 9,000 USD, and you decide to sell. This would put your profit at 6,000 USD per BTC. It’s your responsibility to record this as it could lead to your holdings being assessed at the 9,000 USD value, which could take a heavy toll on your Bitcoin tax.
Tax authorities like the IRS, ATO, CRA, HMRC, and more use many different techniques to enforce crypto tax compliance. For example, the IRS uses data analytics tools to pinpoint crypto users and tie users’ identities on a regulated exchange to their off-exchange wallets. They look at transactions and sometimes share data with other institutions to share information about crypto usage.
While there are a few countries that tax cryptocurrencies, there are also some that don’t—which is why…
Crypto record-keeping is your responsibility
We now live in a time where crypto trading is slowly growing out of its niche market. There are now hundreds of exchanges, brokers, and intermediaries that offer their services in this regard. However, none of them are obligated to provide tax reports to their users/clients. At the end of the day, it’s your responsibility to maintain your crypto transactions’ necessary records if your local government requires you to do so.
Every country looks at crypto taxation in a different light, so be sure to check your home country’s specific regulations—it could keep you from paying a significant amount in taxes and on the right side of the law.