Bitcoin and Tax Season: Accounting for Capital Gains – and Losses

Clay Michael Gillespie for Inside Bitcoins writes:  It’s been nearly one year since the United States Internal Revenue Service (IRS) laid the framework for the tax treatment of cryptocurrency, categorizing bitcoin and all other “virtual currencies” as property.

“If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied,” said the IRS notice.

Some day traders make it their full-time job to watch trends and place quick bets. Along with that, are groups of day traders that utilize bots for automatic trades. Needless to say, record keeping can be quite a chore. According to Colin Mackie, creator of the tax tool BitcoinTaxes, formerly known as Bitcointax.info, anyone coming to tax season with little or no documentation is still responsible for reporting their transactions.

“The responsibility does, unfortunately, fall on the taxpayer to keep records,” Mackie told Inside Bitcoins. “If they were audited, this burden of proof is on them to show what they are claiming is valid and correct.”

Fortunately, most exchanges and wallets have been implementing tools for customers to receive the needed documentation. Still, users without any obtainable records should seek professional tax advice, says Mackie, and they are likely going to need to estimate their tax liability from the records they have on hand.

Capital gains and losses

As with any investment, bitcoin traders need to account for capital gains and losses. For example, if someone purchased one bitcoin at an exchange rate of $600, they would need to report when they sold that bitcoin, the market value at the time of the sale, as well as whether it was at for a gain or a loss.

“This year is going to be a complete reversal of what we saw from last, where those reported gains and capital gains taxes will be somewhat undone by the filing of losses generated in 2014,”

According Mackie, capital gains and losses are going to be a study in contrasts for tax year 2014 as compared to 2013, considering the price declined from near $1000 to almost $300 — with plenty of ups and downs in between.

“This year is going to be a complete reversal of what we saw from last, where those reported gains and capital gains taxes will be somewhat undone by the filing of losses generated in 2014,” Mackie told Inside Bitcoins. “Since wash sales don’t apply to Bitcoins, there was likely a large number of people selling off during December in order to create tax losses for their 2014 filing. Even those that didn’t may well be thinking about it right now whilst we watch the downward trend continue.”

His interest is in how the IRS will respond to the mass amount of capital losses following a year of such high capital gains. According to a recent IRS report to Congress, taxpayers this year are likely to receive the worst levels of taxpayer service since 2001, resulting in the closing of very few audit cases in the coming year. Mackie wonders if the IRS has more important things to worry about than losses, but still believes it could be an issue.

“2013 was probably a revenue windfall for the IRS with the unexpected extra capital gains taxes from the large increases over the year,” Mackie explained. “However, this year, some of those people might well be undoing a lot of those paid taxes with losses. Fortunately for the IRS, the income deduction is capped at $3,000 for investors, although they can be carried forward into 2015 and beyond. A warning, however, if you try and file as a ‘trader’ to avoid that cap is it will likely raise an audit flag.”

Tax tools to lend a helping hand

BitcoinTaxes has an alternative to the bookkeeping mess, for anyone from day-traders to businesses and regular users. People can go to their site and import their trades, income and spending transactions. By obtaining a comma-separated values file (CSV) from exchanges such as Bitfinex, Bitstamp, Kraken or Coinbase, users can input their bitcoin transactions and let the tool create their report. It even has options for the bitcoin core wallet and Blockchain.info.

Similar to the process that BitcoinTaxes uses, LibraTax handles tax accounting as well. It allows for importing transactions from Blockchain.info, Coinbase and CSV files and calculates capital gains and losses.

“Our primary objective is to have approachable, convenient software that simplifies the end-user experience associated with taxpaying — ultimately saving users precious time and money. We’ve accomplished that without a doubt,” said LibraTax CEO Jake Benson, in a product release statement last summer.

Questions on future taxation still linger

While the tax guidelines in place certainly set the groundwork for how the government will handle cryptocurrency, there’s a lot of questions that remain unanswered.

“This was really a minimum and there are still areas to be clarified,” Mackie said, rattling off a list of unanswered questions. “How is the income of mined coined determined if there is no direct USD market? Are consumers really expected to record every purchase they make with Bitcoin and report it as a sale of asset? Do alt-coin trades benefit from like-kind treatments?”

All of these questions have no answer for the 2014-2015 tax season. Assuming that the IRS is still concerned with taxing all cryptocurrencies, it’s expected that a revised guideline will emerge after the upcoming tax season. Any quick changes could lead to less tax revenue to the IRS, making it difficult to put anything into place until audits are challenged and new rules are constructed.