Whether you hold ethereum, bitcoin, neo coin or some other form of digital currency, the IRS has provided guidance on how to treat your crypto portfolio for tax purposes. This may come as a surprise, but the IRS does not tax cryptocoins as a currency but rather as property. Per IRS bulletin 2014-21, “For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.”
So what exactly are the tax principles applicable to property transactions? First off, you will need to calculate your “tax basis.” This is the amount you initially invested in cryptocurrencies in USD. For instance, if you purchased 1 coin of ethereum on Nov. 1 worth $300, and another coin on December 1 at $400, your average cost basis would be your total investment of $700.
Another principle of tax principles applicable to property transactions is capital gains/loss. In order to calculate your capital gain or loss, you would first need to calculate the value of your investment at the time of sale. For instance, let’s say the value of ethereum appreciated to $500 per coin when you sell on December 30. Your total gain would be your 2 coins worth $1,000 – $700 = $300. Since $300 is your capital gain, and since the gain is from holding your investment for less than 1 year, you would pay a short term capital gains tax.
Let’s say instead the value of your investment decreased at the time of sale to $250 per coin. Since you sold at $500 for both coins, your total capital loss would be your tax basis of $700 – $500 = $200. You can claim this as a short term loss in your taxes and at least get a tax deduction from your unlucky trade. The total loss you can write off (including stocks, bonds and any other types of investments), is $3,000 per year. So if you have a capital loss of say $3,500, the $500 loss over the $3,000 allowance can be used as a capital loss in the following year’s tax return.
There are many complex implications of cryptocurrency taxes related to this, and I will discuss these in future blog posts. Thanks for reading!