Today is tax day, the deadline for all Americans to file their tax returns. And recent chatter about cryptocurrencies has been full of mentions about paying taxes on cryptocurrencies. For the first time, people are beginning to think seriously about whether or not they owe taxes on their cryptocurrency holdings. A recent post at CoinDesk illustrates just how difficult calculating taxes on cryptocurrency transactions can be.
Trading Bitcoin, other cryptocurrencies, or other assets that can be used as money such as gold isn’t as easy as using cash or bank accounts. When you convert a bank deposit into cash, you don’t have to pay a tax on that transaction or calculate a cost basis for that conversion. It’s a straight one-to-one exchange. But as soon as you turn that bank deposit into Bitcoin, Litecoin, gold, etc., you start having to worry about capital gains taxes.
If you spend those Bitcoin at a store or sell them later on, you’ll have to calculate your capital gains (or loss). And that holds for EVERY. SINGLE. TRANSACTION. So if you’re actively buying and selling Bitcoin each day, you could be racking up dozens of transactions every day, and hundreds or thousands every year. And every single one of those is a potentially taxable event.
Of course, you also have to figure out your cost basis for those transactions. Are you supposed to use FIFO or LIFO? No one knows, and IRS hasn’t provided any guidance. So many Bitcoin owners and investors are on their own, trying to figure out how to calculate a cost basis.
Then there’s the issue of state taxation. Gold is classified as a collectible at the federal level and is subject to capital gains taxes. At the state level, many states subject gold purchases to state sales and use taxes. Bitcoin is classified as property at the federal level, so does that subject it to sales and use taxes at the state level too, just like any other piece of personal property? Since Bitcoin isn’t physically present in any one locality, just out there in the ether, whose tax rules take precedence? Is sales tax due in the state of the buyer, the state of the seller, the state of the custodian who holds the private keys? What if the Bitcoin is purchased on a foreign exchange, is sales tax even due? There are myriad questions that have yet to be answered, which is why it is hardly surprising that so few Bitcoin and cryptocurrency investors have paid taxes on their holdings.
Thankfully there are other options for investing in Bitcoin and cryptocurrencies, such as a Bitcoin IRA which allows for taxes to be deferred until distribution. Bitcoin IRA investors don’t have to worry as much as other Bitcoin investors, because they aren’t engaged in short-term trading, preferring to hold on to their Bitcoin for the long haul. Still, they will eventually have to sell their Bitcoin holdings due to IRS regulations, so let’s hope that by then the IRS will have established a better cryptocurrency taxation framework to give Bitcoin investors some more clarity on tax issues.