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February 19, 2018 | Posted in:

Taxes and Virtual Currencies: What You Need to Know

Bitcoin, blockchain, cryptocurrency… Digital and virtual currencies are all the rage lately. However, just because there isn’t a physical coin in hand, doesn’t mean they are shielded from taxes. Following are some virtual currency tax consequences you must know if you decide to dip your toe in that world.

“While Bitcoin is the most popular virtual currency there are many others (e.g. Ripple, Ethereum, Lite Coin, etc.). The IRS rules on income recognition apply regardless of which virtual currency you’re using.” — Ren Cicalese III, CPA, MST

 

The IRS is paying close attention

The first thing to know is that the IRS is scrutinizing virtual currency transactions, so if you live in the U.S. you’ll have to report your transactions in Bitcoins and the like to the IRS. Despite some early misconceptions, virtual currency transactions can be traced back to their owners by governments and other cyber sleuths.

In fact, the IRS just won a case late in 2017 against the prominent virtual currency storage company Coinbase, allowing the agency to access records of more than 14,000 customers and assess back taxes on those who haven’t properly reported their transactions.

“If you hold virtual currencies through Coinbase, you are likely to receive a tax form reporting your activity during the year,” points out Ren Cicalese III, CPA, MST. “Copies of this form are sent to the IRS so that they can match it up with the information reported on your tax return.”

If you decide to use or hold virtual currencies, carefully report and pay tax on your transactions. Act as if you are going to be audited, because if you don’t, you just might be!

 

It’s classified as property, not money

Note that the IRS doesn’t consider Bitcoin or other virtual currencies as money, because they aren’t legal tender. Instead, they are considered property. That means that if you are paid in Bitcoin, you will have to report it as income based on its fair market value on the date you received it.

And, if you sell Bitcoin, you have to pay tax on your gain using the cost (basis) of when you received it. The IRS has said that if Bitcoin is held as a capital asset, like a stock or a bond, then you would pay capital gains tax.

“Capital asset holding period rules apply,” advises Rich Middleton, CPA. “If your bitcoin was held less than one year it is subject to ordinary income tax rates.  Bitcoin held more than one year is eligible for preferential long term rates.”

“If the virtual currency is treated as a capital asset, then you could pay tax on any gains at a reduced rate. Long term capital assets can be tax free depending on which tax bracket you fall in.” — Ren Cicalese III, CPA, MST

Otherwise, if it is not held as a capital asset (for example if it is treated as inventory that you intend to sell to customers), it would be taxed as ordinary income.

Example: Charlie Crypto purchased a single Bitcoin on Dec. 29, 2016 for $967. After holding it as an investment (capital asset) for a year, Charlie sold his Bitcoin for $14,492 in 2017. He reports and pays 15 percent tax as a capital gain on his profit of $13,525.

 

Be aware of the risk

In addition to the increased oversight by the IRS, virtual currencies are at risk of virtual theft with no recourse to a government agency like the Federal Deposit Insurance Corporation, which insures U.S. bank balances. Do your research on storage and security before you invest. And if you need help with any tax questions related to virtual currency, don’t hesitate to call.

 
 
The information contained in this newsletter is of a general nature and should not be acted upon in your specific situation without further details and/or professional assistance. For more information or for assistance with any of your tax or business concerns, contact our office at 856.667.4100.

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