Cryptocurrency and the IRS: What Every Investor Needs to Know

If you were lucky enough to be an early adopter of Bitcoin, you are probably sitting on some enormous gains. If you bought into the Bitcoin hysteria and purchased your virtual currency at the peak, you may be sitting on losses instead. But no matter what the situation, you need to understand the tax implications of investing in the cryptocurrency market.

After many years of taking a mostly hands-off attitude, the IRS is now looking at Bitcoin and other cryptocurrencies in a big way. The tax agency has already requested the identifies of certain large-scale investors, and there is every reason to believe they will eventually expand their reach.

If you are an investor in cryptocurrency, it is only a matter of time before the tax man comes calling. The amount of taxes you owe will vary depending on how much profit you have made, but if you have benefited from these virtual coins, you need to understand the potential tax implications. Here are some key things every cryptocurrency investor needs to know about this newfound interest by the IRS.

The IRS Considers Cryptocurrency Property

The classification of cryptocurrency is a big deal, and it can have profound tax implications. While many investors view their cryptocurrency holdings as the virtual equivalent of stocks and bonds, the IRS takes a different approach.

The tax agency has stated that it does not view cryptocurrency as currency. Instead, the tax agency sees Bitcoin and the like as a form of property, putting cryptocurrency in the same category as artwork and collectibles.

That means every cryptocurrency transaction, no matter how large or small, could trigger a gain or loss and be considered a taxable event. Whether you use your Bitcoin stash to buy a cup of coffee or trade it in for fiat currency, you need to calculate your gain or loss and pay taxes on any profits.

How You Get Your Coins Matters

The tax situation for cryptocurrency investors is complicated, and it is only expected to get more confusing going forward. How you get your virtual currency matters, and it can make a huge difference in the kind of taxes you owe and how much you have to pay.

If you do freelance work and get paid in cryptocurrency, the IRS is likely to view that money as ordinary income, probably self-employment income. That could trigger additional self-employment taxes in addition to the income taxes you would already owe.

For miners of cryptocurrency, the tax situation could be much the same. If you mine cryptocurrency, the money you make will probably count as income, and possibly self-employment income. The distinction could come down to how the mining happens. If you work for a mining company and get paid in cryptocurrency, the IRS would probably consider this ordinary income. If you own a mining rig, the tax agency would probably see this as self-employment income, for which you would owe additional taxes.

If you buy cryptocurrency on the open market and later sell it, you will need to report the capital gain or loss. That makes recordkeeping vitally important, especially if you hold your coins in cold storage instead of on an exchange. While many exchanges keep track of the cost basis, investors who stash their cash offline will need to record their costs and pay the appropriate taxes.

Cryptocurrency is Not as Anonymous as Many Investors Think

Some cryptocurrency fans were under the mistaken impression that their transactions were completely anonymous and that this supposed anonymity protected them from taxation. As the IRS starts snooping around and demanding records from exchanges, that assumption is getting put to the test.

Some large cryptocurrency investors have already found out that their supposed anonymity was mostly a charade. Major exchanges keep a wide variety of identifying information, including bank account numbers and even Social Security numbers. When the IRS requests this information, it will likely be handed over. If you are relying on the anonymity of the blockchain, you could be in for an unpleasant surprise when tax time rolls around.

This IRS is taking an increased interest in cryptocurrency transactions, and it takes a dim view of taxpayers who fail to report their holdings and their profits. If you are a cryptocurrency investor, you need to be aware of the tax implications and keep careful records going forward.