In March 2014, the IRS decided that for tax purposes all virtual currencies should be treated as property. This means that every time you engage in a Bitcoin transaction you’re essentially selling property, and therefore have a potential gain or loss on that sale.
Here’s a quick list of potentially taxable Bitcoin transactions:
If all you did was purchase (not earn) Bitcoin one year, then no worries; you’re off the hook for that year. Remember, though, that you will still incur taxable consequences when you sell or spend Bitcoins – so you must keep track of how much you paid for them.
When you earn Bitcoin it’s as if you were getting paid in property. This is income and must be reported on your tax return. The real question is this: how much income must be reported? To determine this, you must know the dollar value of the Bitcoin on the day that you earned it. And since most people earn Bitcoin as a contractor rather than as a W-2 employee, it’s very likely that income will be subject to self-employment tax. Happily, Bitcoin wallets usually calculate the dollar value of the Bitcoin income for you.
When you sell Bitcoin, it’s as if you are selling property; the IRS wants to know if there was a gain or a loss on that sale. If your Bitcoin is worth more when you sell it than when you bought it, you have a gain. If your Bitcoin is worth less when you sell it than when you bought it, you have a loss. Depending on how long you kept the Bitcoin, it might be long-term or short-term.
Spending Bitcoin is exactly the same as selling Bitcoin. It’s treated as if you first sold that property for some number of dollars and then used those dollars to make a purchase; you’ll have a gain or a loss.
If you’ve sold/spent Bitcoin and have a resulting gain or a loss, you’ll have to report those gains or losses on Schedule D. This generally isn’t a do-it-yourself tax return; get help.
If you trade Bitcoin for something else, then the value of the Bitcoin you traded becomes part of the tax basis of the item you received in trade. This is a little too complex to go into on a website.<
To claim a charity deduction or casualty loss, you’ll need to know the original value of the Bitcoin and the value of the Bitcoin on the date of the donation or loss.
Note, please, that you don’t get to just randomly pick which Bitcoin to sell. You must use an IRS-approved technique, the easiest of which is called “FIFO” or “First in, first out”. This means that the Bitcoin you sell must be the Bitcoin that has been sitting in your wallet the longest. Another technique is “Lots”. A “Lot” is a set of assets that have the same price and date. You may choose to sell a certain lot of Bitcoin. The key here is consistency; you don’t get to switch methods whenever you like just to reduce the tax bite. Once you’ve picked a method, you’re stuck with it until you get IRS permission to switch (and good luck with that).