Bitcoin Gains – Tax Advice For US Taxpayers

As Bitcoin has reached five figure levels this week, I have received a number of questions about taxes owed on Bitcoin gains.

That is comforting to me. Bitcoin and crypto are a bit like religion. There are a lot of true believers out there, me included.

But at least some people are stepping back and taking money off the table. I would encourage everyone to think about at least taking their cost off the table and playing with the house money at these levels.

And if bitcoin/crypto has reached an unhealthy percentage of your net worth, I would also recommend stepping back and thinking about rebalancing your asset allocation.

So, if you are US taxpayer, what do you owe in taxes on these gains?

The IRS issued this guidance back in the spring of 2014:

IR-2014-36, March. 25, 2014

WASHINGTON — The Internal Revenue Service today issued a notice providing answers to frequently asked questions (FAQs) on virtual currency, such as bitcoin. These FAQs provide basic information on the U.S. federal tax implications of transactions in, or transactions that use, virtual currency.

In some environments, virtual currency operates like “real” currency — i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance — but it does not have legal tender status in any jurisdiction.

The notice provides that virtual currency is treated as property for U.S. federal tax purposes.  General tax principles that apply to property transactions apply to transactions using virtual currency.  Among other things, this means that:

  • Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
  • Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply.  Normally, payers must issue Form 1099.
  • The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
  • A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. 

Further details, including a set of 16 questions and answers, are in Notice 2014-21, posted today on IRS.gov.

I would strongly suggest folks read that link to “Notice 2014-21” as it includes a lot more information in it.

I have always thought about Bitcoin and other crypto assets like stocks when it comes to capital gains. When you sell the coins, you owe capital gains taxes on the gains.

But how do you calculate the gains?

  • Do you need to identify the exact coins you sold and go back to determine how much you paid for them and then calculate the gain on those coins and the taxes owed? That is like identifying a “lot” when you sell stock.
  • Do you use “first in, first out” (FIFO) to determine which coins were sold and the gains and taxes owed?
  • Do you use the average cost of your entire position and then determine the gains and taxes owed?
  • And if you held the coins for longer than twelve months, do you benefit from capital gains rates vs ordinary income rates?

I assume the answer to the last question is yes and that you can use whichever of the three methods to calculate gains but you need to use them consistently and that requires you to track your buys and sells very carefully.

But I am most certainly not a tax advisor and I do not give tax advice here at AVC. We have very good tax advisors who will figure this stuff out for us.

Hopefully, there are some tax advisors in the AVC audience who will weigh in with answers (and likely more issues to be considered). So if you are an expert in this stuff, please take the time to leave all of some answers in the comments this morning. We appreciate it.