Cryptocurrency on your U.S. tax return
Some people get surprised whenever they realize that they have to pay taxes on the profits they have made from cryptocurrency because they usually would not like to. Many have considered Bitcoin as an important part of their lives, yet they have not anticipated that the IRS would take portions of their profits.
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How can cryptocurrency be accounted for on your US Tax Return?
Oftentimes, people tend to ask how the IRS deals with profits earned from cryptocurrency, especially because this digital currency has become very popular for individuals to invest in.
Cryptocurrency is considered a capital asset. Specifically, if you want to own one, you would have to create an account and put into it money which you would use to buy such.
People who plan to invest in it should keep in mind that the value of cryptocurrency may go up or down at any time. Furthermore, it is important to note that whenever people sell their cryptocurrency, they may make a profit, and that profit would then be considered taxable on their US Tax Return.
One of the difficult things for taxpayers to find out is always the cost basis. Therefore, people should monitor:
- the amount of money that they invest (because this will go toward the cryptocurrency’s cost basis)
- the date when they started investing (because this will help them determine cryptocurrency’s holding period)
Suppose you reside in Australia, and therefore you are dealing with another currency. You opened a cryptocurrency brokerage account there, and you put 10,000 AUD into it. Then, you bought some cryptocurrency, sold some, and eventually made more money. Let’s say that you gained 5,000 AUD, making the total 15,000 AUD. When you convert it to USD, you would have to look at the exchange rate on the date you sold the cryptocurrency, for you to determine whether you have made a profit or a loss.
It may really be a lengthy process because you would still have to figure out the cost basis and the spot exchange rate. The same will apply to the sale date and the exchange.
When you get paid in cryptocurrency in exchange for the services you render, is it considered a capital gain or earned income?
For instance, you are a self-employed individual offering your services to a person who then asks you how you want to be paid (whether in cash or cryptocurrency). In cases like this, the cryptocurrency payment that you receive would be considered an ordinary income. It would then be taxed accordingly on your tax return. Moreover, it would depend on the date when you received the cryptocurrency. For example, you worked on a Tuesday and received the crypto payment on a Friday; Friday should then be the time when the cryptocurrency would be recognized.
If you receive crypto as payment for services, but you don’t sell it till the following year, when does it go on your tax return?
The profit of the income is recognized when you dispose of or sell the asset. Let’s say you disposed of your cryptocurrency, but you keep what you earned in your wallet, and you do not take it out. This is still considered a taxable event. Just like whenever you sell stocks, the fact that you leave your money in your brokerage account doesn’t mean you haven’t made any profit at all. Yet, it should be taken note that when you are disposing of crypto, you may record either a profit or a loss.
Can you use a Foreign Tax Credit to offset the tax you have to pay to the IRS?
Yes, you may use an FTC. The only time you would have to pay for Capital Gains Tax to the IRS is when the other tax offices (such as the Australian Tax Office) have not yet charged Capital Gains Tax on that profit.
Why use the IRS Streamlined Tax Amnesty Program?
It’s for American citizens that didn’t know they had to file US tax returns each year, and have therefore fallen behind. Some more than 30 years! With the IRS Streamlined Procedure, say goodbye to overdue tax returns, late fees, and penalties.
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If you are living in a country where there is no Capital Gains Tax, how much tax will you have to pay to the IRS?
To determine the amount that you will have to pay to the IRS, you would need to consider the holding period of the capital gain which can either be short-term or long-term. If it is short-term, then it can be taxed at marginal tax brackets based on the level of your income. However, if it is a long-term one, it can be taxed at 20% at most.
What’s the time difference between a short-term and a long-term capital gain?
Usually, their time difference is one year. Let us say you have been making a lot of money, and have been holding your crypto for 11 months. It may or may not be a wise decision for you to hold it for another month longer just to turn it into a long-term capital gain. Given this scenario, it would be best to seek guidance from tax professionals because several factors need to be considered (e.g. your tax situation).
You would need to be more conscious about the 12-month period, otherwise you might end up having to pay a lot more taxes on the profit that you have made than if you held your crypto longer to be able to cross the said 12-month boundary.
If you received cryptocurrency as a gift, how would you determine the holding period?
If you received crypto as a gift, the main factor that should be taken note of is the giver’s holding period which will automatically be your holding period as the receiver. Basically, the date when you received it would not matter, but the date when the giver purchased it should be noted.
Conclusion
If you are trading cryptocurrency, the tax event takes place the moment you sell it and make a profit. If you are holding it, it would not matter so much until you sell it.
If you are getting paid in cryptocurrency for the services that you provide, you should take note of the date when you receive it, and not the date when you sell it. Sometimes, if you are eligible, it may be covered by Foreign Tax Credit (or Foreign Earned Income Exclusion).
Further, if you are trading cryptocurrency just for the purpose of investing, you can be on the hook of Capital Gains Tax. If you are already paying capital gains in the country where you reside, you may also be able to take Foreign Tax Credit for that, which may actually be beneficial to you. But, if not, the IRS may come for some of your profits.
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