In recent years and by 2020, cryptocurrencies like Bitcoin have gained significant popularity. This increase in visibility allows policymakers to rely more on the asset. We have recently seen the IRS release new crypto-monetary tax guidelines and begin sending thousands of warning letters to non-conforming cryptocurrency investors. Everyone asks: How is bitcoin treated for tax purposes.
"Go with the assumption that it is up to you and you will keep records and be on Uncle Sam's right side," says Herron.
Crypto Taxes - The Fundamentals
Bitcoin and other cryptocurrencies should, under the official IRS guidance, be treated as property for tax purposes –not as currency. This is the case for all cryptocurrencies as Ethereum, Litecoin, XRP etc. In other words, crypto should be treated as possession of other forms of property like inventory, gold or immovable property. Just like then with trading stocks, you are responsible for reporting taxes on your capital gains and losses from your cryptocurrency company. Failure to do so is seen in the IRS as tax fraud.
Taxable Events for Cryptocurrency
A taxable event is just an action that triggers a tax reporting obligation. In other words, whenever one of these "taxable activities" happens, the reward for your tax return is a capital gain or capital loss. It's so easy. So simple. The following was taken from the 2014 IRS guidance on what is regarded as a taxable event in the world of cryptography. If you have any of the following scenarios, you have a tax reporting requirement.
What if I Lost Money Trading Crypto?
If you have lost your capital instead of making a profit from the trading of cryptocurrency, you can save money on your taxes by filing these losses. Some creditors also deliberately sell crypto assets in order to reduce their tax liability at year-end. This method is usually called tax-loss harvesting. You can read more about the gradual process of collecting tax losses here.
Determining Fair Market Value
This simple calculation of capital gains is complicated by a crypto-crystal trade scenario (please also remember that it triggers a taxable event). Let's look at another example to understand how fair market value is linked.
The Challenge for Traders
This Fair Market Value estimation and definition creates a large number of problems for crypto-traders. Some merchants traded cryptographic products for months or years and did not keep track of the dollar value or fair market value of their cryptography at the time they traded it. In the majority of trades, it is not easy to keep track of USD values as they are often quoted in other cryptocurrency values rather than in USD.
For traders to pay their taxes correctly and to prevent issues with the IRS, this fair market value information is necessary. Depending on the volume of trades carried out, it can become extremely tedious to calculate profits and possibly impossible to do this manually if the fair value is not kept track. Imagine that you have to calculate this for hundreds or thousands of businesses.
Due to this challenge, many users of cryptocurrency turn to crypto-tax software to automate the whole process of tax reporting.
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