The tax treatment of bitcoin and other virtual currencies isn’t always easy to figure out. We’ve created this page as basic primer to help you learn the tax principals applicable to bitcoin. Keep in mind that this information does not constitute legal advice and you should not act upon the information provided below without obtaining specific advice from an attorney. No representation or warranty is given as to the accuracy or completeness of the information provided below, and we do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on this information for any decision based on it.
If you are unsure about how to report your Bitcoin related income on your tax return, click here to schedule a consultation with attorney Tyson Cross.
Bitcoin and other virtual currencies are classified as “property” for federal income tax purposes. This is a broad categorization and implicates general tax principles applicable to all types of property.
Other relevant issues for the classification of bitcoin for tax purposes include:
- Foreign Currency: The IRS does not recognize bitcoin as a foreign currency.
- Security: Bitcoin does not appear to fall within the accepted meaning of a “security” or a “share of stock” for federal income tax purposes. Therefore, code sections prescribing certain rules for securities and shares of stock, such as the wash sale rule, do not presently apply to bitcoin.
- Capital Asset: For most taxpayers, bitcoin is a capital asset. This means that any gain or loss realized on the exchange of bitcoin is “capital” in nature.
- Inventory: Bitcoin is not a capital asset if it is held for sale as inventory in a trade or business.
Every exchange of bitcoin for another type of property is a taxable transaction. This includes exchanges of bitcoin for cash, for goods/services, and even for other altcoins. It is irrelevant whether or not the transaction involved fiat. All that matters is that an exchange occurred, and that the taxpayer received something other than bitcoin as a result.
Therefore, US taxpayers must calculate the amount of their gain or loss on every single transaction involving bitcoin. Gains are calculated by taking the “amount realized” in each transaction and subtracting the “cost basis” of the bitcoins given up. If the amount realized was greater than the cost basis, there is a gain. If it was not, then there is a loss. The total amount of gains and losses are then netted against each other to determine the net gain or loss for the year. Any tax preparation software will automatically perform these calculations.
Other issues relating to the tax treatment of buying, selling, and exchanging bitcoin:
- Cost Basis: “Cost basis” is the original value of an asset for tax purposes, and is usually equal to the purchase price of the bitcoin(s) given up in a transaction. Tracking cost basis gets difficult if the taxpayer purchased bitcoins at different times and at different amounts. The default system (and the one generally preferred by the IRS) is to assume that the bitcoins are sold in the order they were acquired. Thus, the first bitcoin purchased is assumed to be first bitcoin sold. This is called the FIFO method (“First in, First Out”). There are some other methods available, such as LIFO (“Last In, First Out”) and Average Cost Basis, but it’s not clear if bitcoins are eligible for these alternatives.
- Amount Realized: In the case of a sale, amount realized is equal to sales price, reduced by any selling costs incurred in the transaction (like commissions or wire transfer fees). In the case of an exchange of bitcoins for goods or services, then amount realized is the value of the goods or services received in the exchange. In most cases, this would be the price of the goods/services as denominated in fiat currency.
- Reporting gains/losses: Generally speaking, reporting capital gains from the sale/exchange of bitcoin is the same as other types of capital assets (such as shares of stocks). So, net short-term and long-term capital gains are reported on Schedule D of Form 1040. The individual transactions themselves are reported on Form 8949. If there is a high volume of transactions, they can be reported on a separate statement and attached to Form 8949 instead. Note that each and every individual transaction must be reported on Form 8949 or an attached statement.
Bitcoin mining is a taxable activity. Specifically, bitcoin miners have taxable income at the time they successfully mine a bitcoin. The amount of this income is equal to the market price of the mined bitcoin. This will also be the miner’s cost basis in the mined bitcoin if it is ever sold in the future.
Bitcoin mining income is reported differently depending on whether the mining activity rises to the level of a “trade or business” or is merely a “hobby.” The IRS defines a trade or business as an activity engaged in for profit, which the taxpayer conducts on a regular, continuous, and substantial basis. This is a highly factual test and the results will vary depending on the unique factors of each situation.
If a mining activity qualifies as a trade or business, then the income and expenses are reported on Schedule C.
If a mining activity does not qualify as a trade or business, then it is considered “hobby income” and reported Line 21 as “other income.” Mining expenses for hobby income have to be deducted separately on Schedule A as a miscellaneous itemized expense.
Note: If you need assistance determining whether your mining activity qualifies as a trade or business, schedule an appointment for a tax consultation to speak with our tax attorney.
Under Section 1031 of the tax code, exchanges of “like-kind property” do not trigger recognition of capital gains, and therefore can be made tax-free. The question, therefore, is whether bitcoins and altoins are “like-kind property.” The answer is unfortunately highly uncertain. This is because the test for like-kind property under Section 1031 is notoriously vague and difficult to apply. Moreover, virtual currencies are such a unique asset class that its very hard to find relevant case law to help guide the analysis (and support your argument if you decide to treat them as like-kind property).
Regardless, there is one thing that is fairly certain when it comes to this issue: the IRS is not going to agree that bitcoins and altcoins are like-kind property, at least not without a fight. So, it would be wise to wait until further guidance on this issue is given by the IRS. If you decide to use Section 1031 anyways, you should consider obtaining a tax opinion letter from an attorney to back up your position and help protect you from penalties in the event the IRS disallows your use of Section 1031.
Lastly, keep in mind that like-kind exchanges must still be reported using Form 8824.