Tax on Bitcoin: All Queries Sorted!

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It’s been a decade since Bitcoin came into existence and there is still a lack of understanding when it comes to taxes on Bitcoin. Cryptocurrencies are conceived to be a simple medium of digital transaction but in most countries, it is recognized more as a commodity than a currency. The answer to all your queries about tax on Bitcoin lies in this classification of cryptocurrency as a commodity or property.

When you own a piece of real estate, you are bound to pay taxes on it when you either buy more or sell what you have. The same goes for cryptocurrencies; for any cryptocurrency, you buy or sell, there is a tax levied on that transaction. But what if crypto is being donated? Does that incur tax? What if you are receiving crypto as a gift? Who must pay taxes in such cases?

The Internal Revenue Service (IRS) addressed all these confusions in a notice issued in 2014. Tap here to read it. The agency clarified that taxes will be levied on Bitcoins or other cryptocurrencies because all digital assets are considered property. They issue a form where you have to state any possession of cryptocurrencies. These declared digital assets are subject to several types of taxes depending on the type of transaction.

Are All Bitcoin Transactions Taxed?

The IRS sent warning letters to about 10,000 taxpayers who potentially failed to report their Bitcoin transactions in 2019. An incorrect reporting of digital assets can result in interest, penalties, and even criminal prosecution. Now, we know that tax on Bitcoin is legit but are there any exceptions? Let’s find out if all possible transactions are subject to taxes:

  • Sale of Personally Mined Bitcoins

If you mined a Bitcoin, you own it. As long as you hold on to it you need not pay taxes but once you make a sale for profit, you are bound to pay capital gains tax. The transaction must be reported and the necessary tax must be paid.

  • Used Personally Mined Bitcoins to Buy Services or Goods

Now instead of selling mined Bitcoins, you bought a product or a service with it.  This transaction is also subject to tax depending on the price of the product or the service and the value of Bitcoin at the time of the transaction.

  • Sale of Bought Bitcoins

What if you bought Bitcoin from someone or a cryptocurrency exchange and now are trying to sell it? If you make a profit from the sale of bought Bitcoins, you are again eligible to pay capital gains taxes.

  • Used Bught Bitcoins to Buy Services or Goods

You have to pay capital gains tax if you buy a product or a service with a Bitcoin you bought (same as mined Bitcoins).

Personally mined Bitcoin transactions (buying, selling, etc.) are taxed as business or personal income after the expenses during mining have been deducted. Transacting bought Bitcoins is considered an investment in an asset.

Let’s get this even more clear with an example:

You bought Bitcoins for $200.

You sold the same for $300 or used $300 as goods.

The profit you made is $100.

Therefore, you must pay tax on Bitcoin for $100.

Do You Have to Pay Tax When You Convert From One Cryptocurrency to Another?

Yes. When the laws related to tax on Bitcoin weren’t clear before 2021, you could evade tax by converting them to another cryptocurrency as IRC (Internal Revenue Code) classified it as a like-kind transfer under section 1031. After 2021, June 18, the Office of the ChiefCouncil made it clear that cryptocurrency transfer is similar to property transactions and that will incur tax.

What Happens If a Blockchain Goes Hard Fork or If The Crypto Drops?

A hard fork refers to a change in the blockchain protocols like the creation of a new coin. In such cases, these new coins will be given to all the holders of the original coin. An airdrop is a marketing tactic by developers to induce usage and demand.

All queries related to tax on Bitcoin during this situation mostly asked if they are treated as free income, dividends, or stock splits. In 2019, IRS made it clear that there is no gross income during a hard fork but an airdrop can help a holder earn crypto units. So airdrops do bring in gross income and that means you got to pay tax. The tax amount in this case depends on the time and quantity of what’s in the crypto wallet.

The Bottom Line

Tax on Bitcoin is levied because IRS treats it as an asset similar to property. Here’s a brush on what makes Bitcoin unique in terms of tax:

  • Bitcoin is taxed because it is considered property by the IRS.
  • US taxpayers must report their Bitcoin transactions to the IRS for tax purposes.
  • Retail Bitcoin transactions such as the sale of goods will incur capital gains tax.
  • If you are mining Bitcoins you will incur capital gains tax but you can take business deductions.
  • Bitcoin airdrops and hard forks are taxed at ordinary income tax rates.
  • Inheriting, donating, or gifting Bitcoins are treated as cash or property transaction and are subject to the same laws.

FAQs

  • How much tax do you pay on Bitcoin?

The amount of payable tax on Bitcoin depends on your filing status and income. If you have long-term capital gains then you will either pay 20%, 15%, or 0% tax on them.

  • How do I avoid paying taxes on Bitcoin?

All taxes on bitcoin can be avoided if your holding it as an investment and you receive no income on it. Until you sell it, you will not incur any tax on it.

  • What happens if you don’t pay taxes on Bitcoin?

Defaulting on paying taxes on Bitcoin means you will come under the IRS radar. You will then become liable to pay penalties, interests, and even criminal charges. In case you don’t want to pay taxes, hold Bitcoin as an investment in such a way that you don’t receive any income from it.

  • What happens if you don’t file Bitcoin on taxes?

The IRS will notify you when you don’t file your taxes on Bitcoin initially. After 90 days of the issuing of the notice, if you still haven’t filled the taxes on Form 8938, you will face a fine of $50,000.

  • Can you make a living out of Bitcoin?

That’s hard to say because it depends on price charges, trades, and investments. You could live off Bitcoin by selling and buying them within short windows and moving in and out when the market changes. But that way you are more likely to lose money just like stock trading.

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