Although cryptocurrencies are not anything new, 2017 saw traditional investors buy and cash out.
Now they may be looking at some important tax liabilities. But how to apply tax laws to virtual currencies such as bitcoin and ethereum is still a gray area that confuses people.
"I think a lot of people who have entered the cryptocurrency may not have even thought about the tax implications," says Janna Herron, Value Penguin's researcher and tax writer.
The Internal Revenue Service states that transactions in virtual currency are taxable by law. The agency has published its first and only guide on how the tax principles apply to transactions using cryptocurrency in 2014.
"The only warning is considered the tax authority," says Sarah-Jane Morin, a lawyer in the Morgan Lewis tax practice group. "It is not as binding as the regulations, but it is all we have to go on".
The guide says that for tax purposes, cryptocurrencies should be treated as property, not as currency. And the cryptocurrencies in this guide include everything that is considered a "convertible virtual currency", which means that it has an equivalent value in real currency or serves as a substitute for the real currency. Not all cryptocurrencies work this way, but most of the important ones, like bitcoin, do it.
"Some people with bitcoins can think of it as dollars or cash," says Morin. "But for the purposes of the IRS it should be treated as a house, shares, bonds, you have to observe the general tax principles that apply to the property and how it affects your earnings or losses."
Basically, if you bought bitcoins and did not sell, you did not make any money. You probably have no reporting obligations.
But if you sold bitcoins – or any other cryptocurrency – in the last year, you will have to report gains and losses. That's how.
1. The alert is about you
"Usually on sales of shares or bonds, your brokerage company or bank will send you a 1099 tax form," says Herron. "This is not the case for all crytpo exchanges or most transactions."
Coinbase will only issue the statement if you have made $ 20,000 in earnings and have had at least 200 transactions.
It is a high bar designed for the most important players, not for your casual investor who has recently wandered into the bitcoin.
"This means that the burden is on you to understand tax obligations," says Herron.
2. Crypto as a property
Since the IRS determines that cryptocurrencies are properties, such as stocks or real estate, you will have to pay taxes if you have made a capital gain and you can reduce your tax receipt if you have suffered a loss.
You will need to collect the following information: 1) when you purchased encryption, 2) how much you paid for it, 3) when you sold it, and 4) what you received for this.
"I do not think the average person realizes that they need to trace their bases," says Morin, which is the original value of a good for tax purposes.
Usually the base is the purchase price, but it is adapted for things like splits, dividends and capital rents. You will need the basis for determining the capital gain, or the difference between the cost basis of the asset and the current market value.
This can become very confusing if you've made various purchases at different times. "In general, we want to apply a" first in, first out "principle, says Morin.
Alternatively, you can use websites aimed at helping bitcoin investors to determine their tax liabilities. Bitcoin.tax and Cointracking.info will help you understand the history of your transactions, how much you need and how to complete the Schedule D (1040) form to report capital gains or losses.
3. Do not hide trades
It could happen that if nobody reports your earnings captiali to the IRS, nobody really knows about your investments.
"It's never a good idea to try to skip taxes," says Herron. "You really do not want to hide anything from the IRS: in the future they may find out you have to, there will be penalties and fines in this sense".
Although the warning on cryptocurrencies is orientation and not regulatory, it makes comments on the rigors.
"He says taxpayers can be subject to penalties for not reporting," says Morin. "The best way to avoid penalties is to do the best you can with the reports, which will show that you do not intend to avoid taxes".
In some extreme situations, "taxpayers could be prosecuted for failing to adequately report the consequences of income taxes on virtual currency transactions," IRS said in a statement released Friday.
And the sanctions are scarce: anyone convicted of tax evasion, for example, is subject to a custodial sentence of up to 5 years and a fine of up to $ 250,000.
4. Keep a record
This year you may find yourself stuck in a suboptimal situation where you are examining receipts and statements and emails trying to gather all your information.
"Going forward, it would probably be easier to keep detailed records of what you bought and when you bought it," says Morin.
In addition to keeping track of transactions in virtual currency, it is a good idea to put money aside each time you make a taxable transaction to offset the fee associated with that transaction.
Nobody will tell you to do it, but if you do not, you will be responsible for the consequences.
"Go with the idea that it will be up to you and you have to keep those documents to stay on the right side of Uncle Sam," says Herron.
CNNMoney (New York) First published March 26, 2018: 12:00 PM ET