As promised, please enjoy some basic general examples of the U.S. rules for buying Bitcoin as an investment, and later selling it. This is a follow-on to the first Part of the Crypto Tax Blog: Investing in Bitcoin? Let’s Learn U.S. Tax Rules!
Crypto Tax Blog Part I-A, Appendix B
Bitcoin…Taxes? "Help Me Please!"
The examples below are about John, a crypto investor who uses Coinbase. This assumes the cryptocurrency that John holds is an investment & capital asset, and is based on the tax treatment of Bitcoin as “convertible virtual currency”, related to tax guidance in effect as of September 9, 2017 (Notice 2014-21).
Example 1 – Long-term Capital Gain – Sale of Bitcoin for U.S. Dollars
Facts: John purchased 1.0 Bitcoin through Coinbase on August 15, 2017, with the intention of holding the Bitcoin as an investment. The 1.0 BTC was trading at $2,500 USD, but John paid a 4% credit card fee of $100 USD to Coinbase – total $2,600. More than a year later, John sold the BTC back to Coinbase when the market price was 1 BTC = $5,000 USD, however John received only $4,925 to his USD wallet due to a 1.5 % selling fee of $75 USD. John is a U.S. person in the 25% marginal bracket.
Result: John’s gain is:
- $4,925 USD received in the sale
- $2,600 Basis
Because John’s BTC was a capital asset sold after a year, his gain is a long-term capital gain. Due to his marginal tax rate, he is subject to a 15% capital gain tax of $349 ($2,325 X 15% in isolation and assuming no other losses in the current year or carryovers would reduce this amount).
Example 2– Long-term Capital Gain – Exchange of purchased Bitcoin for Ethereum
- (assumes: not a like-kind exchange)*
For this example, Ethereum is assumed to also be a convertible virtual currency (CVC), and “like-kind” exchange is assumed to not apply.
Facts: Assume John purchased 1.0 Bitcoin through Coinbase on August 3, 2017, for investment purposes. The currency was trading at $2,500 USD but John paid a 4% credit card fee of $100 USD to Coinbase – total $2,600 USD. After, two years, John transferred the 1.0 Bitcoin to a personal wallet (still in BTC); then to a separate exchange. On the new exchange, John purchased Ethereum using his Bitcoin as payment, when the price of BTC was, 1 BTC= $6,000 USD (assume all exchanges have the same price). John received 20 Ethereum tokens in exchange for his Bitcoin, when Ethereum was trading at approximately $280 per token ($280 X 20 Ether = $5,600). Transaction fees were not significant. John is in the 25% marginal bracket.
Result: As with Example 1, John’s basis is the $2,600 USD he paid for the 1 Bitcoin. John’s gain is:
- $5,600 value of Ethereum received in exchange
- $2,600 Basis
Because John’s BTC was a capital asset sold after a year, his gain is a long-term capital gain. Due to his marginal tax rate, he is subject to a 15% capital gain tax of $450 ($3,000 X 15% in isolation and assuming no other losses in the current year or carryovers) would reduce this). Note, per Notice 2014-21 Q&A #6, the value of Ethereum John received ($5,600) is used to determine the gain. While we would expect this value of ETH received to be same as the value of the BTC given up, it is not always the case in practice so I highlighted a valuation difference of $5,600 ETH vs. $6,000 BTC, to show which value trumps. Here is the excerpt from the Notice:
"Q-6: Does a taxpayer have gain or loss upon an exchange of virtual currency for other property?
A-6: Yes. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency. See Publication 544, Sales and Other Dispositions of Assets, for information about the tax treatment of sales and exchanges, such as whether a loss is deductible. "
Example 2A – Like Kind Exchange
Had the example #2 above been two-like kind assets in a qualified like-kind exchange (instead of BTC and ETH, imagine two trucks held for investment/business use), there would have been no gain recognition, the $2,600 basis in the old truck would carried over to the new truck, and a gain/loss would not be recognized on the exchange; rather at a later point, such as upon the future sale of the new truck. Whether such like-kind exchange analogy applies to crypto will be discussed in a new article very soon!
Example 3– Long-Term Capital Loss
Facts: Assume John purchased 1.0 Bitcoin for $5,000 USD on September 5, 2017, for investment purposes. After two years, the price of BTC crashed, and John sold the currency online to another person when the price was $1,000 USD. John’s Bitcoin was a capital asset held for investment purposes.
Consequence: John’s basis is $5,000 for 1 Bitcoin. John’s gain is:
- $1,000 Selling price
- $5,000 Basis
($4,000) Loss (see limit discussion below)
In example 3, if there were no other investment transactions for the year, John’s deduction would be limited to a ($3,000) annual capital loss limitation for the year he sold the BTC under Section 1211(b), and then the remaining ($1,000) disallowed loss would be “carried” to the following years, until such loss would be allowable (deduction for 3,000 in year 1, $1,000 in year 2). The same loss treatment would ordinarily apply if the investment was held for less than a year (Short-term capital loss). If John had other investment gains/losses, these other activities would need to be considered in determining the true tax return impact (see a tax advisor).
Example 1-3 Note about Other Fees
Generally, when BTC is transferred to different wallets, a small fee is charged. Fees generally will reduce the gain when the BTC is sold for USD (because the seller ends up with less USD in the end). This is similar to buying stock on the stock exchange, and being charged a fee on the sale. Sometimes these issues resolve themselves in your taxes through the buy/sell data; other times you need to track them.
If John incurs interest charges on a loan to acquire the Bitcoin, he will have the burden of proving to the IRS that the interest was incurred for investing in the Bitcoin and not for personal reasons (or an allocated portion is related to investment if he used the loan for personal expenses and investing). If some Bitcoin is used to make ordinary/small purchases, this will become a more difficult challenge. If the interest can be tied back to the investment, it may be deductible although it hasn’t necessarily been addressed yet by the IRS. A general summary of investment interest (and other deductions/basis additions) can be found in Publication 550, Chapter 3.
Reporting of Examples 1-3
IRS Reporting: In both examples 1-3 above, the basis and selling price for each transaction would most likely be reported by John on Form 8949, as well as Schedule D. In examples #1/2, the net gain would be Form 1040, page 1 assuming no other investment transactions. (Note: a tax software/your tax advisor would examine your specific details to determine the correct reporting; so caution: these examples are a general guide and isolate the specific topic of crypto).
Example 4 –Short-term Capital Gain
If the Bitcoin was held for the short term in examples 1 and 2, the only difference is that the marginal tax rate (“job tax rate”) would apply to the gain instead of the capital gain rate.
Example #1: John’s gain: $2,325 X 25% (marginal rate) = $581 increase to his personal income tax (in isolation and assuming no other losses in the current year or carryovers would reduce this amount).
Example #2: John’s gain: $3,000 X 25% (marginal rate) = $750 increase to his personal income tax (in isolation and assuming no other losses in the current year or carryovers would reduce this amount
Example 5 – Intermediate Examples With Multiple Basis Lots
Intermediate examples, including if BTC was purchased at multiple points in time, and sold in portions, will be provided in the future if there is interest.
Example 6 – Basis/Gain on Disposition of Crypto Received from Mining or Services
Generally, the fair value of the crypto currency is taxable at the fair market value when received as recognized as income; and then, the amount recognized as income is the new basis. In the examples of above, if John earned 1 BTC for services when the fair value was equal to $2,600 USD, then his basis would be $2,600 USD (and holding period likely would start when he received the BTC). A full examination of the tax implications of receiving convertible virtual currency through mining or services, as well as specific issues to the Steem currencies, and examples, will be discussed in separate articles in the future, Part I-B and Part III.
Example 7 – Hard Forked Currency
The tax impact of receiving a new currency from a hard fork, and the impact on of the hard fork on basis of original currency, as well the future sale of each old and new currencies (BTC and BCH), is covered in Part II. I provided specific examples of possible outcomes regarding gain/basis splits, in the link below:
The are specific buy/sell rules for property treated as securities. I recommend seeing the article below if you would like more information. These basic examples above assume BTC/ETH is a capital asset however is not a security.
Did you find these examples helpful/clear? Is there anything you would like me to clarify, or a different fact pattern you would like me to analyze? Please let me know.
After I finish the like-kind exchange article (coming very soon), I am moving on to tax impacts to Steemit authors/curators as well as Miners!
I will try to re-publish a table of contents at the end of every month so that folks can access the articles almost like a book.
Disclaimer: This series contains general discussion of U.S. taxes in an unclear and developing area of tax law. As always, you should consult your own tax advisor in your jurisdiction to determine your specific situation as this is not personal advice; and consider any future guidance by the Congress/IRS after the date of this article. Under Circular 230 to the extent it applies, this article cannot be used or relied on to avoid any tax or penalties in the U.S., its States or any other jurisdictions.