Over the last 12 months, cryptocurrencies have overtaken pretty much every single other traditional asset. Since the beginning of 2018 alone, the value of crypto coins has increased at a rate surpassing 900%. Given this huge increase in value, the likelihood is that investors are going to have to hand over a significant chunk of taxes to the IRS.
Cryptocurrency as property
To be able to understand the tax implications of cryptocurrency trading, it is important to first dispel the myth that the Internal Revenue Service (IRS) treats crypto coins as currencies. According to the IRS, cryptocurrencies are considered as a property when it comes to tax purposes. This means that it is similar to the way that gold or raw materials such as oil is treated. Therefore, the principles and rules that apply to these type of property transactions, also apply to cryptocurrency transactions.
Calculating the cost basis of virtual currencies
The first step in calculating your personal taxes is to find the cost basis of your holdings. This is defined as the purchase price, plus other costs that are associated with purchasing the crypto coin. These could include things like account fees, transaction fees, and commissions payable to brokers. The more cost that you can include in your basis, the less you will be liable to pay in taxes and once you determine the basis, you can calculate your gain or loss at the time of sale.
Determining the fair market value
One of the most important bits of information for cryptocurrency transactions is the fair-market value. This is calculated by using an exchange and referencing the price history in USD at the time of the transaction. You are allowed to use the open, close, or average price for each date as long as you apply this same rule to all of your transactions across the board.
Taxing purchases made with cryptocurrency
They say that only two things in life are certain- death and taxes. The same can be said about cryptocurrency because whilst taxing them may be a grey area, you cannot escape tax even if you use them to buy goods and services. Regardless of whether you sell your coins for USD, the IRS interprets it that you sold the coins.
This approach is not unique to cryptocurrency as companies that trade something for company stick will also incur a similar sort of tax. It is, however, a hassle, if you are making a large number of trades using crypto coins then you must report every exchange and then calculate the gain or loss for each transaction.
Incurring taxes whilst trading
As with stocks, each time you trade cryptocurrency you are incurring capital gains or losses. This comes from the way that the IRS treats commodities in general and the same treatment applies if you traded company stock for tangible property.
One interesting side effect of the way that the IRS treat cryptocurrencies, is that you are still liable for taxes, even if you do not have the cash. For example, if you purchase a Bitcoin for $5000 and then the price goes up to $5100 and you trade it in for $5100 of Ethereum, you have triggered a taxable event and are liable to pay taxes on the $100 of taxable income.
Due to these taxable events, it is very important that you keep an accurate record of these transactions as the IRS places the onus on you and if you cannot provide records then they have grounds to charge you at the highest rate.
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