It’s no secret that the Internal Revenue Service (IRS) is starting to crack down on cryptocurrency traders who it suspects have been misreporting the digital asset on their taxes. The agency has reportedly sent out more than 10,000 warning letters, including 6174 and CP2000, alerting cryptocurrency traders who may have misreported the asset on their tax returns. 

With bitcoin’s 2019 price rise and increase of more than 180 percent in the year to date, it’s likely that many traders have incurred capital gains that will need to be reported on their year-end tax returns. 

Bitcoin and other cryptocurrencies are treated as property in the eyes of the law not as currency. This means that cryptocurrencies are subject to capital gains and losses tax rules just like other forms of property — stocks, bonds, real estate, etc.

A capital gain is simply the rise in value of a capital asset. In the world of bitcoin and cryptocurrency, you incur a capital gain when you sell or trade a coin for more than you acquired it for. Just as if you sold a stock or a piece of real estate for more than you bought it for, you owe a tax on this gain.

For example, if you purchased 0.1 bitcoin for $2,000 in April 2019 and then sold it two months later for $3,000, you have a $1,000 capital gain. You report this gain on your tax return, and depending on what tax bracket you fall under, you will pay a certain percentage of tax on the gain. Rates fluctuate based on your tax bracket as well as depending on whether it was a short-term or a long-term gain. 

A taxable event is simply a specific action that triggers a tax reporting liability. In other words, whenever a “taxable event” happens, you trigger a capital gain or capital loss that needs to be reported on your tax return. Taxable events also apply to cryptocurrency. The following has been taken from the official IRS guidance from 2014 as to what is considered a taxable event in the world of cryptocurrency. If any of the below scenarios apply to you, you have a tax reporting requirement:

So, in the example above, you trigger a taxable event with your sale of your $3,000 worth of bitcoin. You would also trigger a taxable event if you traded that $3,000 worth of bitcoin for another cryptocurrency, say 5 ETH. 

Again looking at the example above, let’s say you never sold or traded your $3,000 worth of bitcoin. Just continuing to hold the asset does not trigger a taxable event. You only incur the capital gain when you trigger a taxable event.

To properly file and report your cryptocurrency transactions, you need IRS Form 8949 and 1040 Schedule D.

You should list all of your taxable events — i.e., cryptocurrency trades/sells — onto Form 8949 along with the date you acquired the cryptocurrency, the date it was sold or traded, your proceeds (fair market value), your cost basis and your gain or loss. Once you have each trade listed, total them up at the bottom of the form and transfer this amount to your 1040 Schedule D. Include both of these forms with your yearly tax return. 

This is where a big problem exists.

Because users are constantly transferring cryptocurrency into and out of exchanges, the exchange has no way of knowing how, when, where or at what cost basis you originally acquired your cryptocurrencies. It only sees that they appear in your account. 

The second you transfer cryptocurrency into or out of an exchange, that exchange loses the ability to give you an accurate report detailing the cost basis and fair market value of your cryptocurrencies, both of which are mandatory components for cryptocurrency tax reporting.

The IRS is making it a top initiative to educate and ensure that citizens are remaining compliant with tax regulations surrounding digital assets. I think it is very likely that we will continue to see more cases of the agency enforcing these rules, potentially in a more aggressive manner, in the coming future.

This is a guest post by David Kemmerer. Opinions expressed are entirely his own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

The post Op Ed: Are You Paying Taxes on Your 2019 Bitcoin Gains? appeared first on Bitcoin Magazine.

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