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  • With the explosive growth of Bitcoin and other cryptocurrencies in the later part of 2017, everyone was enjoying huge profits off of either trading, investing or mining Bitcoins. While in the moment, most people simply enjoyed the profits they were recognizing and didn’t worry about much else, especially taxes on cryptocurrency. Proper tax planning and understanding the tax laws is crucial any time that you make money, and taxes on Bitcoin is no different.

    How are Bitcoins Taxed?

    Back in 2014, likely due to the run Bitcoin had in late 2013, the IRS issued guidance on how Bitcoin and other digital currencies are to be taxed. This notice is known simply as IRS Notice 2014-21, and it is the only official guidance that we have as to how to deal with Bitcoins. The short explanation is that cryptocurrency is treated as property, which means it is taxed in a very specific way. When an asset is considered property, each time there is a transaction with that property, it is considered a taxable event. (For those who mine Bitcoin, please see our post on “How is Bitcoin Mining Taxed?“)

    So What Does That Mean?

    The key to this definition is that every transaction is a taxable event. This does not mean every time that you cash out into fiat, or USD. It means that every time you make a trade, you need to figure out the tax implications on that trade. For example, here is a sample of a few transactions that can occur before you cash out. You decide to buy 1 Bitcoin at $6,000. Bitcoin then shoots up to $8,000 and you decide to sell that 1 Bitcoin for 20 Ethereum at $400/coin for a total of $8,000. Ethereum goes to $500/coin, so your total investment is now worth $10,000. You decide to try an altcoin and sell your 20 coins, but the altcoins drop in price a bit to a total value of $9,000. You decide to cash out with a value of $9,000, which in the end, is a total profit of $3,000.

    This is where it gets a little tricky. Sure, in the end, you are paying taxes on the $3,000 gain no matter how it is reported. However, the proper way to do this is to report the sale and profit of Bitcoin of $2,000, the sale and profit of Ethereum for $2,000 and the sale and loss of the altcoins of $1,000. The benefit of splitting it out this way is that it can lower your taxable income in one year, especially when you are making larger profits. If the transactions were done say from December to January, then you could split the profits over the two years, depending on when the transactions took place.

    What Tax Rate is Bitcoin Taxed At?

    Any transaction that is done within one year is taxed as ordinary income or the same rate that you would pay on your income from a job or a business you own. If you hold your cryptocurrency for over a year before your next transaction, then you are taxed at a more favorable capital gains rate. For 2018, the long-term capital gains rate is either 0%, 15% or 20%, and the levels are based on your income. It is very advantageous for investors to hold on to their cryptocurrency at least for a year if it makes sense, as the tax savings are huge.

    This is a very basic level of how Bitcoins are taxed, as well as how other crytocurrencies are taxed. Most investors have much more complicated situations than this, and there are plenty of special circumstances that pop up. Again, the IRS hasn’t kept up with the market in terms of how to handle profits and losses on certain situations in the crypto space, so tax professionals are doing our best to apply the guidance that we do have based on our knowledge of how to handle property.