It recently came to light that the Revenue Service (IRS) has been using bitcoin transaction tracking software in an attempt to identify citizens who have not been paying capital gains tax on their bitcoin investments.
Interestingly, in 2015, the same year when the IRS purchased the tracking software from blockchain startup Chainalysis Inc., only 802 Americans reported their bitcoin income to the tax authority. That number seems somewhat low, doesn’t it? It would appear that the majority of bitcoin users in the US have chosen not to declare their bitcoin profits.
However, bitcoin investment returns need to be appropriately reported and taxed under federal tax law.
How Does The IRS Categorize Bitcoin?
The IRS treats bitcoin and other digital currencies as “intangible property” for Federal tax purposes and, therefore, requires individuals to tax their bitcoin investment returns using the same capital gains and losses tax form, Form 8949, as they would to declare profits and losses on their stocks and bonds portfolio.
Furthermore, individuals who receive payments in bitcoin for goods or services rendered are required to declare these bitcoin payments as income, for which standard income tax rules apply.
How Should You Report Your Bitcoin Investment Income to the IRS?
Firstly, to record your digital currency investment income, you should apply the realization method as opposed to mark-to-market accounting. That means that you record the profits or losses you have made after you have sold part or all of your bitcoin investment and not at the value it is when you file your taxes.
Secondly, report each trade separately on the Form 8949 (Sales and Other Dispositions of Capital Assets) to ensure transaction transparency for the tax authority as opposed to using summary reporting.
Thirdly, make use of the holding period rules and divide your bitcoin investment income between short-term and long-term (12 months or longer) realized gains or losses. The capital gains tax rates on the latter are lower. Hence, it could be tax-beneficial to differentiate your bitcoin investment income between the two.
It also important to note that the $3,000 capital loss limitation against other income applies, in case you have had investment losses within the tax year.
Software That Can Help You With Bitcoin Taxation
While you are perfectly fine to use a spreadsheet to record your bitcoin trades or to utilize your trade history from the exchanges you use, you could also seek the service of bitcoin taxation reporting software providers such as Coin Reporting and Bitcoin Tax. Both companies provide their users with an easy-to-use bitcoin taxation tool that enables users to accurately keep track of all their digital currency trades to ensure appropriate tax reporting.
If you are unsure about how to best go about declaring your digital currency income on your tax forms, it makes sense for you to consult your tax advisor to ensure that you are filing your bitcoin income investment correctly.
Bitcoin investment can be a lucrative endeavor. As with all capital gains (or losses), you must report any gains or losses resulting from bitcoin investment to the IRS on the appropriate forms.