Cryptocurrency and Tax Implications

Cryptocurrencies were the rage until December 2017 when the Bitcoin pricing reached all-time highs of close to $20,000 after having been as low as $1,000 in January of that year. The pricing of Bitcoin was only 7 cents when trading started in 2010. By the end of 2018, the value of the Bitcoin had dropped down to $3,500. When you invest in Bitcoins, you need to consider how they are taxed.

As you sit down to prepare for your taxes, you will need to consider any cryptocurrencies that you have dealt with during the last year. The Internal Revenue Service (IRS) has ordered the Coinbase cryptocurrency exchange to provide them with all the data pertaining to transactions involving more than 14,000 customers who bought, sold, received, or sent $20,000 or more of bitcoins from 2013 to 2015, which makes it appear that the IRS is ready to scrutinize tax returns and levy the necessary penalties and taxes for any bitcoin transactions.

The proponents of cryptocurrency seemed to be shocked by the move, but taxes are imminent, regardless of the nature of the financial dealings in which the profits were obtained. If you bought and/or sold cryptocurrencies, you will need to prepare for your next tax filing by gathering the proper documentation.

Recordkeeping for Bitcoin Transactions

Cryptocurrency trading is available from a variety of intermediaries, brokers, and exchanges. None of those are under obligation to provide you with tax reports, but some, at their own discretion may do so. In the long run, you as an individual is responsible for maintaining all supporting documentation and records that pertain to any cryptocurrency transactions and dealings. As an example, if you purchased 10 bitcoins for $3,000 each about 8 months ago. Imagine that today those coins are worth $5,000 each, which gives you the potential to profit $2,000 per coin.

If you don’t have the proper documentation to show how much you paid for the bitcoins, your bitcoins could be assessed at the current value of $5,000, showing your overall bitcoin value at $50,000 rather than indicating a $20,000 profit, which could have a major impact on your overall tax burden. Any of your bitcoin transactions could be subjected to taxes. If you obtain bitcoins and if you spend them, you are expected to maintain the equivalent dollar value for each bitcoin and compute your net income from each of those coins.

How Bitcoin Taxation Works

To properly maintain records that are suitable for filing your taxes, you will need to understand how the different kinds of transactions are taxed. Depending on the specific bitcoin dealing, there are different scenarios that could come into play. If bitcoins are received as payment for providing services or goods, it doesn’t matter how long you hold them. They are taxed as ordinary income and should be reported as such.

If you receive bitcoins from mining activity, they are treated as ordinary income. Self-employment taxes may be payable if you receive bitcoins as payment for mining, services, or goods. If you buy bitcoins as investment and then sell them for profit, how long you hold the bitcoins affects the treatment of the income. If you hold them for a period of less than a year, you will treat your net receipts as ordinary income, but if you hold them for longer than a year, they will be considered as capital gains and could be subjected to an additional 3.8 percent tax on top of the investment income.

To make sure your bitcoins are properly handled in your tax filings, work with a skilled professional. Contact the experienced tax professionals at MKS&H to understand cryptocurrency and its tax implications.

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About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture, and your business goals. This approach enables our clients to achieve their greatest potential.

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