We are super excited to kick off this new series covering in depth issues with Bitcoin taxes within the United States. Bitcoinist will be partnering with Daniel Winters of Global Tax, LLC to bring you weekly content. This weekly series will run every Thursday up until the tax deadline of April 15th, and after that point, the series will become a bi-weekly publication, as there are still many topics to cover. In addition to the extremely valuable information to be gained from this series, our readers will have a chance to interact and send in questions to be answered on a weekly basis in the next article, this will be explained more further down. Let’s kick off the series by introducing Daniel and his firm.
Daniel Winters, MS Taxation, MBA
Daniel is active in the New York Bitcoin community and is making his second presentation on Bitcoin and Taxes on February 12, 2015 at the NYC Bitcoin Center. In addition, he has authored a technical article for tax practitioners about Bitcoin and Taxes and is actively engaged with US and European firms offering accounting software specifically designed for Bitcoin transactions.
Daniel has over 12 years of tax experience and is a former expatriate who lived and worked in Poland from 1992 to 2000. He holds a Masters of Taxation from Seton Hall University, NJ and an MBA jointly issued by the University of Calgary, Canada and the Warsaw School of Economics, Poland. Before founding Global Tax Accountants, Daniel was employed by top tier accounting firms such as KPMG, Ernst & Young and Schoenbraun McCann.
- Taxation of Bitcoin and crypto currencies
- Taxation of U.S. citizens resident abroad and U.S. companies with international
- Taxation of partnerships (LLCs), S corporations and high net worth individuals
In addition, Daniel recently completed the technical review of an International Taxation course for the American Society of Certified Public Accountants. He reviewed course content for compliance with federal tax law, updated course content and wrote exam questions. Daniel also speaks fluent Polish and enjoys traveling.
As you can see, Daniel has some very impressive credentials. We are very fortunate that he has chosen to share his knowledge with us.
The Basics, Trading, and Capital Gain
We will now jump into Daniel’s content for this week which will cover tax basics, Bitcoin trading, and capital gains:
Since tax law differs from state to state, the articles in this series will cover only federal tax issues. Other articles will cover working for Bitcoin, mining, selling goods or services for Bitcoin, why Bitcoiners may need to file a Foreign Bank Account Report (FBAR). Also, tell us what you need to know – ask some questions in the comments and we’ll respond in the next article.
On March 21, 2014 the IRS issued Notice 2014-21, which describes how Bitcoin and other “virtual currencies” are treated for federal tax purposes. Under the Notice, virtual currency is treated as property, NOT currency. Though Bitcoin and other virtual currencies are a new type of capital asset, the IRS has well established rules for handling the sale of capital assets. The sale and exchange of Bitcoin is therefore treated similarly to the sale of other capital assets, such as stocks.
When you buy Bitcoin, then later sell or exchange the Bitcoin, you will have a gain or loss on the transaction. For individuals, Bitcoin which is sold after being held for more than 1 year is taxed at long-term capital gains rates, usually 15%, but a 20% rate applies to taxpayers in the top tax bracket. For individuals, Bitcoin which is sold after being held for 1 year or less is taxed at ordinary income tax rates up to 39.6%.
Unfortunately, there is NO minimum threshold for reporting Bitcoin transactions. This is consistent with stock sales – brokerage firms frequently report sales for under $1. Since issuing the notice, the IRS has updated the instructions for filing 2014 tax returns. The new instructions for reporting capital gains and losses on Schedule D specifically mention Bitcoin and virtual currency. In addition, the instructions for Form W-2, Wages, also include language describing the treatment of wages paid in Bitcoin.
Transactions in virtual currency must be reported at their fair market value in USD, therefore we need to convert the Bitcoin to USD using an appropriate exchange rate. The IRS stated only that Bitcoin must be converted into USD in a reasonable manner which is consistently applied. As we all know, Bitcoin’s price is unstable and can go up or down 10% in a day. Also, rates vary between exchanges located in different countries, and different exchanges in the same country.
So, what do we do? Choose one source for the exchange rate, and use the same source for converting ALL Bitcoin transactions in the same year.
Now we’ve covered the basics, let’s look at some examples:
1. Johnny Quinoa buys 1 Bitcoin on January 15, 2013 for $10. He sells the 1 Bitcoin on January 16, 2014 for $1,000. Johnny’s gain is computed as follows: Proceeds of $1,000 less cost basis of $10 = $990 gain. This is long term capital gain.
2. Same facts, but with a different sale date. Johnny Quinoa buys 1 Bitcoin on January 15, 2013 for $10. Johnny sells the 1 Bitcoin on December 31, 2013 for $1,000. Johnny’s gain is computed as follows: Proceeds of $1,000 less basis of $10 = $990 gain. This is short term capital gain.
So far, we’ve assumed that Johnny purchased the Bitcoin using fiat currency, then sold the Bitcoin for fiat currency. Instead, what if Johnny bought the 1 Bitcoin using 10 USD, then later exchanged the 1 Bitcoin for another virtual currency? Some would argue that this is a “like-kind” exchange and that no tax is due until Johnny cashes out to fiat. We disagree and believe this situation is treated identically to selling shares of IBM and purchasing shares of Google.
- Johnny Quinoa bought 1 Bitcoin on January 15, 2013 for $10.
- It is now January 15, 2015, and 1 Bitcoin has a fair market value of $300.
- Johnny wants to buy a new virtual currency called LowTaxCoin using the 1 Bitcoin.
- He will purchase 2 LowTaxCoins in a direct exchange using 1 Bitcoin.
These are the tax consequences:
Proceeds of $300 less basis of $10 = $290 gain. This is long term capital gain. Johnny now owns 2 LowTaxCoins. Each has a cost basis of $150 (300/2). When Johnny later sells the 2 LowTaxCoins, he will need to calculate the gain / loss on the transaction using the $150 cost basis.
Since any exchange of Bitcoin should be reported on your taxes, it is extremely important to keep good records. Fortunately, LibraTax.com can import Bitcoin transactions from many major wallets, and can even import transactions directly from a public Bitcoin address.
Any tax-related opinions in any part of this document or website (including any links) are not tax advice. The above is a general explanation of tax law and should not be relied upon for your individual circumstances. Tax advice cannot be provided on a general basis, and must be specifically tailored for each individual by his or her particular representative. Any user of this website should seek the advice of a competent, independent tax professional regarding that user’s particular circumstances.
In addition, any tax advice given herein (and in any attachments) is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (i) avoiding tax penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed therein.
Special thanks to Daniel for explaining the basics of tax law, cryptocurrency trading, and how capital gains work. Daniel also explained an incredible resource for calculating capital gains: Libratax, which is completely free to use. Be sure to leave your questions in the comment section. Each week, Daniel and I will select certain questions to be answered in next week’s article. If you have very specific questions or need help with you taxes, please visit Global Tax, LLC
In our comments section below ask tax related questions and we will answer some of them each week as well as new ones in this ongoing Bitcoinist exclusive series.