There are five events that may occur with your cryptocurrency (Bitcoin or any of the thousand others) that can trigger some unusual tax situation:
#1: You mine a cryptocurrency.
It could be Bitcoin, it could be ethereum or something else. The US tax law is the same.
When you mine a coin, you create an asset (and income) based on the fair market value (FMV) that day. Your expenses that go into mining are either capitalized assets like equipment or fixtures that need to be depreciation or just straight expenses like your ISP and home office. If you are efficient in your mining efforts, you’re going to have a profit (FMV of the coins minus your expenses.) That is taxable as business income. That means you’ll pay state and federal income tax on the net income plus you’re subject to self-employment tax of 15.3% unless you operate through a corporate structure. In that case, you’ll just have federal and state income tax.
#2: You sell your cryptocurrency.
When you sell your cryptocurrency, you will have either a gain or a loss on the sale. If you held the crypto for over a year, it’s a long term capital gains/loss. If you held it for exactly one year or less, it’s short term. Losses can only be deducted on your return up to the extent of your gains plus $3,000.
#3: You buy something with your cryptocurrency.
The IRS ruled that cryptocurrency was NOT currency. It’s considered an intangible asset.
That seemingly obscure difference means everything when it comes to your taxes. If you use your crypto to buy a product or service, it is considered a sale of the cryptocurrency. You need to report each instance and report it as a short-term or long-term capital gain or loss, based on your basis in the coin and the fair market value of the service or product you bought.
#4: Your coin declares a “dividend.”
Cryptocurrency is not a stock, so it can’t declare a dividend in the real meaning of the word. Bitcoin did a large “dividend” of Bitcoin Cash for everyone who owned Bitcoin at August 1, 2017. The Bitcoin Cash fair market value of the “dividend” you received on August 1, 2017 needs to be reported on your tax return as “other income.”
#5: You trade your cryptocurrency for another cryptocurrency.
With one word, the 2018 Tax Cuts and Jobs Act changed how like-kind exchanges work. A trade is taxable. You have to report short-term or long-term capital gain or loss on the sale of the first crypto. There is no such thing as a like-kind exchange for cryptos.
And the #1 mistake most cryptocurrency miners and owners will make, is thinking the IRS can’t find you.
Yes, they can. And they likely will, sooner or later. Make sure you’re compliant with applicable laws.