A Tax Guide to Crypto Currency
This is for US investors and traders, if you want to see an article about your country comment below.
Crypto Currency, per the IRS, is to be treated as property meaning that it is subject to capital gains tax and depending on whether the unit was held a year or more can be either short term or long term capital gain. The long term capital gain rate is a more favorable tax rate than your ordinary income tax, but requires you to hold the unit for at least a year. If you are holding a unit of crypto currency for less than a year it will be taxed at the same rate as your income tax bracket i.e. if you are in the 25% bracket you will pay 25% tax on your capital gains. (To figure out what tax bracket you are in, check this Forbes article for 2017). When you are holding long term, you will have no capital gains tax until you move out of the 15% tax bracket, but you will have 15% capital gains taxes until you make over $418,400 of taxable income for a single filer (compared to the income tax at that bracket of 35%).
In order to figure your gain, you will need to track what you bought the unit for, plus any additional purchase cost. So if you buy one unit for $100 and there is 1% processing cost, your total basis would be $101. You will then take the sales price and subtract the basis from it to calculate the capital gain. If you sold the same share for $150 with processing cost of 1%, your capital gain would be $47.50 ($150-$1.5-$101). The capital gain is what is taxed at capital gains rates, not the total of the final sale, which is why it is crucial to determine your basis and the holding period.
The IRS has no mandated accounting process for tracking your holding period capital gains, but the most common would be First In: First Out (FIFO), Last In: First Out (LIFO), and Highest Price: First Out (HPFO). While FIFO and LIFO are pretty self-explanatory, HPFO means that regardless of holding period you are trying to minimize capital gains initially by having the highest price units sold first. While this may sound like a good idea at first, you may run into issues with short and long term gains depending on how long of a holding period you have (If you are in the 15% income tax bracket it is the difference between owing no capital gains tax and 15%). You will want to try to stick to an accounting method for as long as you can, otherwise you will face scrutiny from the IRS if you are constantly changing methods without reason. If you are going to use the HPFO method, I would recommend using an excel spread sheet to track your purchase and sale transactions, noting the date, price, transaction costs, and total units. If you need help setting this up feel free to contact us for our free excel template.
Dave, a single and employed man making $35,000 per year, buys 10 units of Ether at $100 and sells them a month later at $150, realizing a short term gain of $500 (keeping himself in the 15% tax bracket) will owe capital gains tax of $75. If he were to wait a year and sell them for $150 his capital gains tax would be $0 until he crossed into the next tax bracket.
In my experience tax laws have always been a reactionary solution and seldom a proactive solution, this has never been more apparent than in the tax treatment of crypto currency. While the IRS has posted a notice about crypto currency (Notice 2014-21), there are still several questions that have yet to be answered. In the next article we are going to review some strategies for classifying yourself as a trader to reduce the amount of capital gains that you are paying taxes on. If there are questions that were not answered by this article feel free to shoot us an email and we will work that into the next article.
If you want info from the IRS and Tax Code checkout the following links: