How Will my Cryptocurrency Sales Affect my Taxes?

Bitcoin and other cryptocurrency (altcoins) are becoming a popular form of online payment and a lucrative investment opportunity for some individuals. However, because you never “see” cryptocurrency, it's easy to forget that it is an asset. As with the sale of any asset, a taxpayer can incur tax liabilities. Failing to pay taxes owed on the sale of bitcoin or cryptocurrency can cause fines, penalties, interest, and other tax consequences by the Internal Revenue Service (IRS). Before filing your tax return, it may be wise to consult a Maryland tax attorney to ensure you report the sale of cryptocurrency correctly on your tax returns.

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 What is Cryptocurrency?

Bitcoin, the first form of cryptocurrency, was introduced in 2009 and continues to be one of the most widely recognized forms of digital currency. It was described as a “peer-to-peer electronic cash system” by the creators. Other forms of cryptocurrency include Ripple, Litecoin, and Ethereum. The currency has no physical form.

A person does not need a bank or other financial institution to purchase or transfer the currency. All transactions for cryptocurrency are handled online with an encryption key. A digital public ledger called a blockchain record and stores all cryptocurrency transactions. The owner of the “coins” has an encryption key that allows access to the digital currency he or she owns.

How Does Bitcoin and Other Cryptocurrency Impact My Tax Liability?

Initially, the IRS did not prioritize cryptocurrency because only a few individuals dealt in digital currency. However, now that Bitcoin and other forms of digital currency have gained in popularity, and increased substantially in value, the IRS is interested in ensuring that taxpayers report cryptocurrency correctly on their tax returns so the IRS can tax digital currency transactions as allowed by the tax code.

The IRS views digital currency as property. Therefore, the applicable tax code for cryptocurrency is typically the portion of the code that relates to capital gains or losses. However, some transactions involving digital currency may be treated as income for the owner.

Now that Bitcoin and other forms of digital currency have gained in popularity, and increased substantially in value, the IRS is interested in ensuring that taxpayers report cryptocurrency correctly on their tax returns so the IRS can tax digital currency transactions as allowed by the tax code.

For example, trading, exchanging, and spending cryptocurrency may cause a short-term or long-term capital gain or loss. On the other hand, initial offerings, receiving payments for services or products, air drops (on the day of the drop), and mining are all considered income for tax purposes. Therefore, you must carefully analyze the cryptocurrency transaction involved to determine whether you need to include the value of the altcoins as income or a capital gain/loss.

Tips for Avoiding Cryptocurrency Tax Problems

Cryptocurrency is a challenging tax topic. Taxpayers must be very careful to avoid tax problems related to altcoins. Some things that you can do to avoid a problem with the IRS regarding your bitcoins or other cryptocurrency include:

  • Maintain complete and accurate records of each cryptocurrency transaction. As with other tax matters, documentation helps you prepare your tax returns correctly and backs up your information if the IRS audits you. Your records need to be up to date. Record all transactions at the time of the transaction to avoid issues at tax time.

  • Keep detailed records for capital gains and losses. The transfer or sale of digital currency could increase your tax liability (gains) or reduce your tax liability (loss). However, to determine whether you realized a gain or loss, you need detailed information for each transaction, including the date of purchase of the currency, purchase amount, date sold/transferred, amount received, and the basis for your valuation of the purchase/sale price.

  • Self-report your digital currency transactions to the IRS. Usually you will not receive a 1099 for cryptocurrency transactions. Therefore, use your records to correctly self-report all transactions to reduce the chance of additional taxes, interest, and penalties associated with altcoin transactions.

 Contact a Maryland Tax Attorney for Help

The tax rules and regulations regarding cryptocurrency may change as digital currency becomes more popular, and the IRS seeks to tax the transactions with greater efficiency. A Maryland tax attorney can review your cryptocurrency transactions and explain how each transaction impacts your tax liability. Your attorney can also help you develop strategies for reducing your overall tax liability. Contact Thienel Law today. Maryland tax attorney Steve Thienel is dedicated to assisting clients in Maryland, Virginia, and throughout the DC Metro area.