Calculating your bitcoin tax liabilities

Wednesday 12 March 2014

Bitcoin has only been around since 2009 and already we have had several countries come out with views on it, such as China and, most recently, the UK. Some viewed it as dangerous and banned it, others viewed it as private currency, and others viewed it as just another financial asset.

However, if you live in a country like the United States, it is a bit difficult to know how to treat bitcoins. Is it to be taxed? It is uncertain, as the IRS has given no guidance as of yet. For the sake of not being accused of tax fraud, however, many are considering taking it upon themselves to pay taxes on bitcoins this year.

How are bitcoin taxes going to work?
As of now, the IRS has given no word on how to treat bitcoins with regards to taxation. If you don’t “forget” to report bitcoin-related gains, theoretically any means of calculating gains is valid. Even though the IRS prefers the First-In-First-Out (FIFO) method of calculating gains, it is possible to calculate them via other measures such as Average Costing, Last-In-First-Out (LIFO) and Highest-In-First-Out (HIFO).

How am I supposed to monitor my bitcoin activity?
Given that bitcoin exchange rates have fluctuated wildly, it is difficult to keep track your bitcoin activity for tax purposes. While exchanges tend to present you with a log of your trade history, it would be a very tedious process to calculate tax liabilities, especially if you are an active trader. A service by the name of bitcointaxes.info has recently risen to the challenge of streamlining this process.

Taxman: bitcointaxes.infoHow does it work?
In order to use bitcointaxes.info effectively, you must first import your trade history for any exchange(s) you use in the “Trades” tab. Currently, there are 8 exchanges and services supported such as Cryptsy, Coinbase, Btc-e, and even LocalBitcoins. You can import your own spreadsheet containing all of your relevant trade data, or manually add individual trades. Every imported spreadsheet and trade added will show on your account and will factor into your calculated tax liability.

If you happened to be trading or mining bitcoins prior to the 2013 tax year, then you can enter all of the relevant data in the “Opening Positions” tab. This, too, may be relevant for tax purposes this and future tax seasons.

To calculate your capital gains, you simply view the “Calculate Gains” tab, which by default calculates gains based on the FIFO method. The FIFO method, in this case, matches your most recent amount of BTC sold to the oldest amount of BTC purchased. So, for example, let’s say I purchased my first bitcoin (1 BTC) for $30 many months ago and continued purchasing bitcoins at $600 today. The instant I sell one bitcoin, my capital gains tax is based on the first bitcoin I bought at $30. The other methods of calculating tax liabilities, which include HIFO, LIFO, and Average Costing are only available if you pay for a yearly subscription.

With regards to how many remaining bitcoins you hold, there is the “Sales and Closing Position” tab. This section allows you to view your closing position in terms of BTC, which is reportedly your remaining bitcoin balance when considering all of your bitcoin trades. This is useful mainly for the next tax year. You can also export this data in a format that can be used in an application like TurboTax if you pay for a yearly subscription.

Should I pay bitcoin-related taxes?

This is a bit of a difficult question, as currently there is no US tax perspective on bitcoin and bitcoin-related gains. While there may not be specific mention of cryptocurrencies within tax policy, “forgetting” to report your bitcoin gains or income can hold penalties should you be audited. Ergo, regardless of your philosophic or political persuasion, it may be best to report bitcoin-related gains when doing your taxes this year.

Check out more articles on developments in bitcoin

Daniel Mestre


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