04-30-2025, 02:29 PM
Topic 4: Losses *
#20: What happens if end up with an overall loss (instead of a gain) from my bitcoins? First, remember that gains and losses are combined at the end of the year to reach the amount of your “net gain.” If you had more losses than gains, however, then you will end up with a "net loss." Given the two large market crashes bitcoin suffered in 2013, it's possible that some of you will find yourself in this position. Net losses are deductible on your tax return, but there are some important limitations depending on whether they are characterized as "capital" or "ordinary" (character is discussed above).
#21: Can I deduct my net losses if they are “capital?"
Yes, but subject to a $3,000 maximum per year. This limitation is painfully low if you have substantial losses. Fortunately, any losses in excess of that amount can be carried forward and deducted in subsequent tax years (still subject to the $3,000 maximum each year). There is no limit to how long you carry your capital losses.
#22: Can I deduct my net losses if they are "ordinary?"Yes. Ordinary losses are fully deductible and not subject to the $3,000 limitation mentioned above. If your net losses are so big that they offset all of your other taxable income, you get to carry the unused losses back two -years (by amending your prior tax returns) as a Net Operating Loss. Any remaining NOL can then be carried forward for an additional twenty years.
Keep in mind that most bitcoin holders will not have "ordinary losses." The only time your losses will be characterized as ordinary is if (1) you are in engaged in a trade or business with bitcoins as inventory (which is possible in the case of bitcoin miners, although it is still unresolved), or (2) bitcoins are categorized as a foreign currency and your losses did not arise from a "personal transaction."
Note: this answer ignores the possibility of passive activity or at-risk limitations, which may be applicable and need to be addressed on a case-by-case basis with a tax professional.
Topic 5: Deductions *
#23: What kind of expenses can I deduct as an investor? *
You are permitted to deduct investment related expenses as an "itemized deduction." However, this deduction is fairly meaningless for most investors. This is because you must actually itemize your deductions instead of taking the standard deduction, which many taxpayers do not. Additionally, such expenses fall within the category of "miscellaneous itemized deduction," which are only deductible to the extent they exceed 2% of your Adjusted Gross Income. The 2% floor is particularly troublesome because most “miscellaneous itemized deductions” are pretty insignificant, particularly investment related expenses. Recall that you've already accounted for commissions and wire transfer fees in determining "amount realized" and "basis." Your remaining expenses might include:
· Interest paid on funds that you borrowed in order to invest (limited to the amount of your net gains),
· Rent expense for a safety deposit box (this could arguably be extended to include the cost USB drives for cold storage),
· Consulting fees for the tax treatment of bitcoin,
· Depreciation on equipment used in the production of income, such as your computer (however, you'll have to allocate the cost of the equipment between personal use and investment use, which is likely to reduce this deduction substantially in most cases).
In most cases, these deductions will be quite small. Other expenses may or may not be available to you, depending on your specific situation, though. You should consult with your tax advisor to be certain of your deductible expenses. There are also a myriad of resources online if you have questions about what kinds of expenses are deductible by investors.
#24:What kind of expenses can I deduct as a miner?
If your mining operation is substantial and continuous enough to be considered an actual business, then you can deduct all of your ordinary and necessary expenses. This would include the cost of electricity and depreciation on your mining rig, among others. If your mining operation is not substantial or continuous, you would deduct expenses like an ordinary investor.
As mentioned above, the tax treatment of bitcoin miners is exceptionally uncertain. So, its important that you obtain the advice of a tax professional with regards to whether or not your activity rises to the level of a trade or business.
Topic 6: Record Keeping *
#25 What kinds of records should I keep? You are required to maintain records sufficient for determining the amount of your gain or loss, as well as the holding period of your bitcoins. This is a flexible standard and depends on the circumstances. Ideally, you should maintain a log of all your bitcoin acquisitions and dispositions, including the price, date, and related address of each transaction. Many exchanges make this information available to you in the form of a downloadable spreadsheet.
#26: How long should I keep my records? *
The IRS can generally go back and audit your tax returns for a period of 3 years. That period is extended to 6 years if your tax return omitted more than 25% of your income. Finally, there is no time limit if you are charged with civil fraud or never filed your tax returns. Thus, it is advisable that you save your records for at least three years after filing your tax return, although you might consider keeping them at least six years to be safe.
#27: What if I don't maintain records?
You are required by law to maintain records, so failing to do so will result in civil penalties if you are subsequently auditedandowe additional tax. This means that if you have no records of your bitcoin purchases/acquisitions, you might consider claiming a zero basis and characterize your gains as short-term if you want to avoid penalties. This makes sure you’ve paid the maximum amount of tax possible on your gains, and hence there cannot be any additional tax to which a penalty can attach.
Penalties aside, it is in your best interest to maintain records because the burden is on you to prove your basis. Thus, if you cannot reasonably establish your purchase price, the IRS will assume it is zero. The same goes for holding period (which would cause you to lose the benefit of the lower long term capital gains rate).
This assumption can be disastrous if you engage in a lot of bitcoin transactions. For example, consider a day trader who buys $2,000 worth of bitcoins after seeing a specific market signal, which he then sells shortly after for a small profit of $100. He does this once per day. If he is subsequently audited and lacks the necessary documentation to prove his basis, the IRS will assume it was zero. Thus, he would be taxable on $2,100 of gain every single day, instead of just $100. That is a total taxable gain of $766,500 for the year, compared to $36,500if he had kept adequate records. In addition, he would be subject to penalties on top of the additional tax.
#20: What happens if end up with an overall loss (instead of a gain) from my bitcoins? First, remember that gains and losses are combined at the end of the year to reach the amount of your “net gain.” If you had more losses than gains, however, then you will end up with a "net loss." Given the two large market crashes bitcoin suffered in 2013, it's possible that some of you will find yourself in this position. Net losses are deductible on your tax return, but there are some important limitations depending on whether they are characterized as "capital" or "ordinary" (character is discussed above).
#21: Can I deduct my net losses if they are “capital?"
Yes, but subject to a $3,000 maximum per year. This limitation is painfully low if you have substantial losses. Fortunately, any losses in excess of that amount can be carried forward and deducted in subsequent tax years (still subject to the $3,000 maximum each year). There is no limit to how long you carry your capital losses.
#22: Can I deduct my net losses if they are "ordinary?"Yes. Ordinary losses are fully deductible and not subject to the $3,000 limitation mentioned above. If your net losses are so big that they offset all of your other taxable income, you get to carry the unused losses back two -years (by amending your prior tax returns) as a Net Operating Loss. Any remaining NOL can then be carried forward for an additional twenty years.
Keep in mind that most bitcoin holders will not have "ordinary losses." The only time your losses will be characterized as ordinary is if (1) you are in engaged in a trade or business with bitcoins as inventory (which is possible in the case of bitcoin miners, although it is still unresolved), or (2) bitcoins are categorized as a foreign currency and your losses did not arise from a "personal transaction."
Note: this answer ignores the possibility of passive activity or at-risk limitations, which may be applicable and need to be addressed on a case-by-case basis with a tax professional.
Topic 5: Deductions *
#23: What kind of expenses can I deduct as an investor? *
You are permitted to deduct investment related expenses as an "itemized deduction." However, this deduction is fairly meaningless for most investors. This is because you must actually itemize your deductions instead of taking the standard deduction, which many taxpayers do not. Additionally, such expenses fall within the category of "miscellaneous itemized deduction," which are only deductible to the extent they exceed 2% of your Adjusted Gross Income. The 2% floor is particularly troublesome because most “miscellaneous itemized deductions” are pretty insignificant, particularly investment related expenses. Recall that you've already accounted for commissions and wire transfer fees in determining "amount realized" and "basis." Your remaining expenses might include:
· Interest paid on funds that you borrowed in order to invest (limited to the amount of your net gains),
· Rent expense for a safety deposit box (this could arguably be extended to include the cost USB drives for cold storage),
· Consulting fees for the tax treatment of bitcoin,
· Depreciation on equipment used in the production of income, such as your computer (however, you'll have to allocate the cost of the equipment between personal use and investment use, which is likely to reduce this deduction substantially in most cases).
In most cases, these deductions will be quite small. Other expenses may or may not be available to you, depending on your specific situation, though. You should consult with your tax advisor to be certain of your deductible expenses. There are also a myriad of resources online if you have questions about what kinds of expenses are deductible by investors.
#24:What kind of expenses can I deduct as a miner?
If your mining operation is substantial and continuous enough to be considered an actual business, then you can deduct all of your ordinary and necessary expenses. This would include the cost of electricity and depreciation on your mining rig, among others. If your mining operation is not substantial or continuous, you would deduct expenses like an ordinary investor.
As mentioned above, the tax treatment of bitcoin miners is exceptionally uncertain. So, its important that you obtain the advice of a tax professional with regards to whether or not your activity rises to the level of a trade or business.
Topic 6: Record Keeping *
#25 What kinds of records should I keep? You are required to maintain records sufficient for determining the amount of your gain or loss, as well as the holding period of your bitcoins. This is a flexible standard and depends on the circumstances. Ideally, you should maintain a log of all your bitcoin acquisitions and dispositions, including the price, date, and related address of each transaction. Many exchanges make this information available to you in the form of a downloadable spreadsheet.
#26: How long should I keep my records? *
The IRS can generally go back and audit your tax returns for a period of 3 years. That period is extended to 6 years if your tax return omitted more than 25% of your income. Finally, there is no time limit if you are charged with civil fraud or never filed your tax returns. Thus, it is advisable that you save your records for at least three years after filing your tax return, although you might consider keeping them at least six years to be safe.
#27: What if I don't maintain records?
You are required by law to maintain records, so failing to do so will result in civil penalties if you are subsequently auditedandowe additional tax. This means that if you have no records of your bitcoin purchases/acquisitions, you might consider claiming a zero basis and characterize your gains as short-term if you want to avoid penalties. This makes sure you’ve paid the maximum amount of tax possible on your gains, and hence there cannot be any additional tax to which a penalty can attach.
Penalties aside, it is in your best interest to maintain records because the burden is on you to prove your basis. Thus, if you cannot reasonably establish your purchase price, the IRS will assume it is zero. The same goes for holding period (which would cause you to lose the benefit of the lower long term capital gains rate).
This assumption can be disastrous if you engage in a lot of bitcoin transactions. For example, consider a day trader who buys $2,000 worth of bitcoins after seeing a specific market signal, which he then sells shortly after for a small profit of $100. He does this once per day. If he is subsequently audited and lacks the necessary documentation to prove his basis, the IRS will assume it was zero. Thus, he would be taxable on $2,100 of gain every single day, instead of just $100. That is a total taxable gain of $766,500 for the year, compared to $36,500if he had kept adequate records. In addition, he would be subject to penalties on top of the additional tax.