Bitcoin IRS Tax Guide For Individual Filers

As with any investment, individuals venturing into the cryptocurrency space must also learn about the tax repercussions of their investment decisions. Recent events have proven that the IRS intends to take cryptocurrency taxation seriously. In Feb. 2018, for example, the popular crypto exchange Coinbase contacted 13,000 of its customers to inform them that, per IRS request, Coinbase had shared the "taxpayer ID, name, birth date, address, and historical transaction records for certain higher-transacting customers during the 2013-2015 period." 

In this tutorial, we’ll examine the implications of IRS Notice 2014-21, a set of guidelines and rules for investors which was first issued in early 2014. 

One of the major implications of IRS Notice 2014-21 is that the U.S. government has decided to treat cryptocurrencies like bitcoin as property instead of as currency. The result is that a wide-ranging group of bitcoin stakeholders—everyone from consumers and merchants to bitcoin miners and service providers—will now fall under the larger umbrella of bitcoin “investors” in some way or another, and this group will now have to deal with complicated and sometimes daunting reporting requirements.

The first thing that we’ll look at in this tutorial is what any individual who has explored the cryptocurrency investment arena should talk about with his or her tax adviser before filing personal tax returns ahead of the April 15 deadline. Let’s assume that our prototypical investor “Max” is married, and he and his spouse made $100,000 in total taxable income for the previous tax year. How should Max report trading gains and losses for bitcoin and any other cryptocurrency investments? How does this relate to purchases that he made with those currencies? If he lost funds in a wallet that was affiliated with an exchange that was hacked or which became defunct, what does he do? What happens with cryptocurrency gifts or tips he has given or received?

Trading Gains & Losses

Perhaps the most important thing to keep in mind is that the IRS has determined that bitcoin will be considered property, not a currency. For most investors, particularly those who have been in the bitcoin game for a long time, this is a favorable ruling; accrued long-term gains and losses will be taxed at each investor’s applicable capital gains rate (15% for Max) as opposed to at ordinary income rates (this would be 25% for Max). Bitcoin miners and investors may see a huge difference in marginal rates as a result of this distinction. Nonetheless, active traders with short-term capital gains could still be taxed at their ordinary income-based rates, so it’s a good idea to consult with a tax professional.

The fact that bitcoin is property and not a currency makes losses that much more difficult to write off, on the other hand. For the IRS, net capital (or property) losses are capped at $3,000 per year for married and single filers on personal tax returns. This limit has been in place for nearly 40 years. This means that large short-term trading losses may have to be carried forward for years. This places investors who have suffered trading losses in a disadvantageous position compared to what they would have been able to write off with “foreign currency” losses against ordinary income.

Next up, we’ll take a look at how the concept of fair market value applies to bitcoin and other digital currencies with regard to taxes.