The signs of early spring are here and they include warmer weather, pollen and hay fever, putting the winter coats away, and TAXES.
Bitcoin investors and lenders, especially those in the US, have some quirky laws that they have to deal with in order to stay compliant. As I talked about in a previous post, Bitcoin is taxed like property in the US. This means that we have to do the same things with Bitcoin that we do with stock and bond investments and we have to track them the same way without the benefit of a Fidelity or Vanguard or Goldman Sachs to help us.
DISCLAIMER: I do finance for a living but I am NOT a CPA. Please doublecheck with your own tax and financial advisors.
Step 1: Track Your Purchases and Sales
The first thing you need to do in order to accurately assess your tax liability in BTC is to track your purchases and sales of BTC. I have a spreadsheet that I put together that looks like this for tracking purposes:
Just like with stocks, when you buy 1 BTC for $650 (which you may have in Summer 2014 like I did) and sell it for $325 (which you may have in December 2014), you would be left with a $325 capital loss. Capital losses can be written off against Income and Capital gains are taxed at their own rates depending on if they are short term or long term gains.
Short term gains, held less than 1 year, are taxed at your ordinary income tax rates. So if your tax rate is 28%, then that is the tax you pay on your short term capital gains. Long term gains, held more than 1 year, are taxed at 0, 15 or 20% for most tax payers. Long term gains are usually taxed at a lower rate.
Where do you log this information in your spreadsheet to determine your capital losses or capital gains? on IRS Schedule D. This is the form where you determine your total losses or gains and whether they are long term or short term. If you look at the form, you can see in Part III that the amount of gains or losses (with certain exceptions) goes right onto your 1040 form to increase or decrease your potential tax liability.
Remember, on purchases, you are only taxed when you sell OR if you received BTC as payment for services then you have to track the BTC/USD rate on the day you received your payment so you can accurately reflect your business revenues and then again when you sell.
Step 2: Track Interest Earned
If you lend your coin out like I do, then you need to track your interest earned. Are you tracking it? So far, every attempt by the Bitcoin lending platforms to track Interest has been incorrect, although some are closer than others. Here is how I track mine per loan:
This will require your spreadsheet and your loan platform to calculate your Interest on an ongoing basis.
Interest goes on a different form than Capital Gains/Losses does. Interest goes on the Schedule B form of the 1040. Looking at the form, you see that Interest goes in Part 1 and line 4 of Total Interest Earned goes right to your 1040. This means that Interest is taxed as Ordinary Income, just like your short term capital gains. It's taxed at your own personal marginal tax rate.
Step 3: Track Defaults
The easiest way to track your defaults is through Schedule D directly OR Form 8949. Form 8949 tracks the Sales and Disposition of Capital Assets. Virtually all Bitcoin defaults are short term so you could go direct to the Schedule D or you can fill out this form and move the loss from your defaults to your Schedule D, which would move through to your 1040 and reduce your tax liability.
No one likes thinking about these defaulted loans but you can and should take advantage of the tax laws to write off these losses against income you have earned.
All of the lending platforms have good data on the defaulted loans so take advantage and use it.
Lastly, remember, only Interest Earned, Gains/Losses Made and Defaults before year end 2014 count for this tax year.
This is by no means a complete guide, however, there should be enough here to get you started and gather some information to make it easier for you and your CPA and cheaper for you if the CPA doesn't have to track this down themselves.