Thinking about making the leap into cryptocurrency? In 2017, Bitcoin saw a surge of popularity and went from an obscure idea amongst tech savvy investors to a legitimate investment source that created billionaires as the price of Bitcoin skyrocketed.
Priced at just under $1,000 in the beginning of 2017, Bitcoin’s price peaked in December 2017 at over $17,500.[i] Those who were able to purchase or mine Bitcoin have earned thousands, even millions, of dollars – and the IRS is anticipating a piece of that income.
Bitcoin is just one of the many cryptocurrencies available as an open-source digital currency. These digital currencies are not controlled by the government in the same way as the dollar. Instead, it uses a process by which transactions are verified and added to the public ledger known as a block chain to keep track of legitimate transactions.[ii]
For some, the idea of cryptocurrency may be farfetched and it was a largely unknown concept to most of the general public until recently. Bitcoin has been around since 2009, but it wasn’t the first of its kind and it likely won’t be the last.[iii]
Currently, virtual currencies are popping up everywhere due to the massive success of Bitcoin. Other block chain focused technologies that are gaining in popularity include Ethereum, Ripple, Litecoin, Dash, and Monero.[iv] For investors who can stomach a high risk for cash rewards similar to Bitcoin, cryptocurrencies may offer an opportunity to transform their portfolio.
Bitcoin and Your Tax Return
If you’ve been fortunate enough to earn a profit from investing in cryptocurrencies, the IRS is looking for you to claim it on your return. The IRS views digital currencies in the same way it would any other property. The IRS has released an outline of how you claim your earnings and losses on your cryptocurrency.
Here are the key takeaways from the IRS FAQs regarding digital currencies that you’ll want to know if you’ve invested in Bitcoin or are looking to diversify your financial portfolio through digital currency.
Mining Your Own Virtual Currency
Does your day consist of mining Bitcoin for yourself? A self-employed Bitcoin miner is subject to self-employment tax on their gross earnings that they have earned through their mining.v
Claiming Gains or Losses from Virtual Currency
For those that view a cryptocurrency in the same way they would a stock or bond – the IRS agrees. Your fair market value is the cryptocurrency’s value in U.S. dollars when you first purchased it. If you sell those currencies, you will need to claim any gains or losses that the sale of that currency provided.[v]
Using Cryptocurrencies as Payment
Whether you’re paying or being paid in digital currency, the IRS expects you to keep track of those exchanges. A payment of Bitcoin for goods or services should be claimed at the fair market value in U.S. dollars of the cryptocurrency at the time of sale. If you are receiving Bitcoin or other cryptocurrencies as payment for your work, you will need to claim that as well.v
Looking for a better understanding of all of the laws and guidelines related to the IRS’s policy? View their entire outline of virtual currency guidelines by visiting IRS.gov. Talk to a tax professional to fully understand the implications virtual currencies may have on your tax filings.
Getting Started in Cryptocurrency
Investing in anything can be a risky endeavor with no guarantee you will earn a profit and the chance that you may lose some or all of your investment. Cryptocurrency is no different. It is relatively new, untested, and has shown sharp highs and lows in its value over the past few years.
If you are looking to purchase Bitcoin or another cryptocurrency, you approach it a little different than you do other investments. One option is using the algorithm to mine it yourself. There is also a much easier way which involves just a few moments on your personal computer or mobile phone.
First step, you will need to set up an online wallet. There are a variety of Bitcoin and block chain wallets available. A wallet provides you with a private key comprised of long strings of numbers and letters that, similar to a bank account number, allows the block chain ledger to recognize who is making the purchase.[vi]
From there you use an online Bitcoin exchange to make your purchase. There are a wide variety of options in the marketplace. To find the best one for you, talk to a financial advisor who is knowledgeable about cryptocurrencies. They can help guide you to a secure exchange.
With new financial risks, it is always important to speak with as many experienced professionals as possible and do your own research to make sure you are comfortable with your investment.
Still Not Sure?
If you have any doubts about investing in the new cryptocurrency market, it may not be the right investment for you. Look toward more stable and traditional investments. Also diversify your savings plans by ensuring you have dependable returns through insured financial tools like high yield certificates of deposit, IRAs, and an emergency savings account.
While cryptocurrencies have created a few billionaires, it is unlikely to be the case for everyone. Find an investment plan that you and your family feel comfortable with.
[v] “Notice 2014-21” Internal Revenue Service https://www.irs.gov/pub/irs-drop/n-14-21.pdf Accessed 3/2/2108.