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Tax Implications For Settling Cryptocurrencies For Cash

Come on, come on

It’s all about the Benjamins, baby (uh-huh, yeah)

It’s all about the Benjamins, baby (uh-huh, yeah)

It’s all about the Benjamins, baby (uh-huh, yeah)

It’s all about the Benjamins, baby (uh-huh, yeah)

-P-Diddy, It’s All About The Benjamins

You are feeling like the luckiest man in the world. You brought a lot of bitcoins back in 2013 when most people laughed at you for doing so. When everyone started buying bitcoins at $10,000 each, you got bitcoins when it was $100 per bitcoin. Now, every time you wake up in the morning, your alarm plays “It’s All About The Benjamins.” You started to hate going to your job so you told your boss to “take this job and stick it!” You quit that same day and cashed out of bitcoins when it was $20,000 per bitcoin. You are a millionaire now and party every day like it is 1999. Years past and the IRS never wrote to you about the bitcoin sale transactions. Now, fresh back from your European vacation, you receive a letter from the IRS. It basically says, “by the way, where is our money?” Uh oh, all the money is spent! Okay, let’s talk about it!

Cryptocurrency gains from trading coins held as capital assets are treated as investment income by the IRS, and the same capital gains rules apply. In this situation, the man who sold bitcoin positions for cash should have reported a capital gain on Form 8949. Form 8949 are for sales and other dispositions of capital assets. A bitcoin position held for one year or less is considered a short-term capital gain, taxed at ordinary tax rates; a position held for more than one year is considered a long-term capital gain. In this situation, the man would have a long-term capital gain. Receiving long-term tax treatment is more favorable than short-term tax treatment.

Capital losses can offset capital gains in full, and a net capital loss is limited to $3,000 ($1,500 for married taxpayers filing separately) against other types of income on an individual tax return. An excess capital loss is carried forward to the subsequent tax year. The good news is that the man in this situation made a sizeable profit. The bad news is that there were no capital losses to offset the gain. For example, lets say that he brought bitcoins back in 2017 when it was $20,000 per coin but sold it in 2019 when it was $11,000 per coin. Then if he sold one coin, he can deduct only $3,000 in capital losses on his 2019 tax returns. Then he can deduct $3,000 in capital losses in 2020 and 2021 each.

Recordkeeping is extremely important. Under IRS rules, the default for stock transactions is the first-in, first-out (FIFO) method of accounting. Under certain circumstances, however, specific identification is allowed. The use of specific identification can drastically reduce the recognized gain on cryptocurrency transactions since many traders have multiple transactions in the same form of cryptocurrency. I highly recommend that you have a discussion with your accountant on which method works for your situation. Don’t compare your situation with your friend’s situation. Everyone’s tax situation is unique and should never be compared.

General tax principles that apply to property transactions must be applied to exchanges of cryptocurrencies as well. Since 2013, the gain is also considered investment income for purposes of the Medicare contributions tax introduced in the Affordable Care Act. As a result, the man in this situation has modified adjusted gross income over $200,000 and therefore subject to the 3.8% additional Medicare tax on his cryptocurrency gains. Therefore, not only is he responsible for capital gains, he must take into account the additional Medicare tax. If he is amending his tax returns he may be hit with underreporting and accuracy-related tax penalties. Sounds like the former luckiest man in the world needs to call a qualified tax accountant as soon as possible

Need help with your crypto taxes? Well, contact Jamaal "Crypto J" at jamaal@jstaxcorp.com!

Podcast: https://anchor.fm/36chamberscryptotaxes

Website: www.36chambersofcryptotaxes.com

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