With the explosive volatility of Bitcoin and other cryptocurrency prices in recent years, you could face significant capital gains or losses. You must report these to the IRS each year when you file your taxes, and Form 8949 is the place to start.
You will have to pay capital gains tax on any gains, although you can get a deduction for any losses you realize, which will reduce the taxes you owe. While you may think that crypto transactions are untraceable, some companies report your transactions to the IRS on Form 1099. If you don’t report your winnings, the IRS will come knocking on your door and ask for a stop to the action.
“Cryptocurrency is an area the IRS continues to focus on for enforcement,” said Brian R. Harris, tax attorney at Fogarty Mueller Harris PLLC in Tampa, Florida. He emphasizes that even if you do not receive a 1099 or another statement from your exchange, you must still report the income.
Here’s what you need to know about reporting your gains and losses and how to use Form 8949.
Form 8949: Who Should Use It?
It is important to understand that you will not owe cryptocurrency tax if you have not realized any taxable gain. However, unlike other types of investments, you can realize profits on cryptocurrency in two ways:
- Buying crypto and then selling it for a profit in a taxable account
- Exchange crypto for goods or services that are worth more than you paid for them
If one of these cases applies to you, you have a taxable capital gain and must legally declare it. (Here are other ways you can get tripped up by crypto taxes.)
However, if you realized a gain in a tax-advantaged account such as an IRA, you do not need to report your transactions. That’s none taxable to deserve. Crypto is not widely available in IRAs, although the rise of Bitcoin ETFs makes it easier to invest in cryptocurrency in an investment account.
Finally, if you’ve suffered a loss while trading cryptocurrency, it’s worth declaring that as well, as you can take a deduction and reduce your tax bill. That may be cold comfort if you lose money, but you do get a tax break for it.
How to report your cryptocurrency capital gains
Before completing Form 8949, you must declare at the top of Form 1040 that you have traded in cryptocurrency. The IRS requires all filers to report whether they received or sold digital currency in the applicable tax year.
When you report your realized cryptocurrency gains or losses, use Form 8949 to review how your transactions will be treated for tax purposes. You then enter this information on Schedule D, which totals your net capital gains and losses.
On form 8949 you report when you bought the cryptocurrency and when you sold it, and at what price you did so. The purchase and sale dates are important because the time you owned your cryptocurrency determines how much you will be taxed on it.
If you owned your cryptocurrency for less than a year, any gain will be taxed at short-term capital gains rates, which are the same rate as your ordinary income rates. These rates can be as high as 37 percent, so they may be higher than you would have to pay if you qualified for the long-term rates. Short-term sales are reported in part 1 of the form, as below.
However, if you owned the property for more than a year, it is considered a long-term investment and eligible for more favorable treatment. The long-term capital gains tax rates are zero percent, 15 percent or 20 percent, depending on your income level.
Sales of long-term investments are reported in Part 2 of the form, which looks much the same as Part 1 above.
It is also worth noting that if you generate income from cryptocurrency wagering, you are also required to declare this. But that income appears elsewhere on your tax return.
Provide the details of your crypto gain/loss on Form 8949
After you determine whether your gain or loss is short-term or long-term, you must enter the details of the transaction in the appropriate section of Form 8949. Each transaction requires the same pieces of information entered in Part 1 (for short-term transactions) or Part 2 (for long-term transactions), in the relevant column.
For most transactions, complete the following:
(a) The name or description of the asset you sold
(b) When you bought it
(c) When you sold it
(d) What price you sold it for
(e) The cost or other basis of the asset
(h) The gain or loss
Once you have detailed all your transactions on Form 8949, add up your entries and then transfer the information to the corresponding sections of Schedule D. On Schedule D, you subtract your cost basis from the total proceeds to arrive at your total capital gains . or loss. From there, Schedule D determines how much tax you owe or what type of deduction you receive.
What if you don’t receive a 1099 from your crypto exchange?
All brokers and some crypto exchanges provide detailed information about your trades every year on a Form 1099. The tax form usually contains all the information you need to complete Form 8949. However, crypto exchanges may not provide a 1099, requiring you to do some work, although the best crypto brokers can provide this.
“There may be more informational reporting in the future, and these exchanges will report more information about digital assets and cryptocurrency,” Harris says.
Without that reporting, it is a lot more difficult for traders to calculate their potential profits and losses.
“It’s up to you to determine your holding period, your cost basis and your returns,” says Harris.
That means looking through the records of your transactions, noting the purchase and sale dates, proceeds, and anything else required on Form 8949. That’s no one’s idea of a fun Saturday afternoon, but it can become even more complex because of the so-called ordering rules.
Ordering rules determine which tax lots are sold and when, meaning they determine whether a given sale is a short- or long-term investment.
Imagine you bought 100 bitcoins in January, 100 in February, and another 100 in December. In March of the following year, you sold only 250 for a profit. You benefit both in the short term (for assets held for less than a year) and in the long term (for coins held for more than a year). But how do you divide the tax over the short and long term?
Harris says that unless you can identify a specific individual bitcoin unit, you should use what’s called “first in, first out” accounting. This means that you first account for the oldest purchases until you have added up all the coins sold.
Continuing the example from above, you will make a long-term profit on the first 100 coins you bought in January and the second 100 coins you bought in February. The next 50 coins would be counted as short-term gains as they were only held from December to March of the following year.
You must divide the transactions this way and report them based on their retention period on Form 8949.
How to report profits on the cryptocurrency you spend
As mentioned above, cryptocurrency trading is not the only way you can make a taxable profit. IRS rules also allow you to spend money on cryptocurrency profits, a fact that makes using cryptocurrency as an actual currency tricky.
“When you spend cryptocurrency, it is a sale or exchange of cryptocurrency and can be a taxable event,” Harris says. “For example, if you exchange crypto for a pizza, you have a profit or loss compared to the fair market value of that pizza.”
You need to figure out what the fair value of your purchase is (in dollars) and then compare that to your cost basis (what you paid for the cryptocurrency). Then, to determine your holding period, you need to determine when you purchased the crypto and the date you spent it.
Add up the profits and losses from these types of purchases and enter them in Form 8949, just as if you were trading cryptocurrency otherwise.
In short
Form 8949 allows you to report realized capital gains and losses, ensuring that your taxable gains are recorded correctly and that you are not taxed more than you should be. It also ensures that if you have suffered a loss, you can claim any taxable benefit you are entitled to.
Finally, although you may not receive a statement of your taxable income from a grant, this does not absolve you of the responsibility to report and pay your tax liability.
Need an advisor?
Do you need expert guidance when it comes to managing your investments or planning your retirement?
Bankrate’s AdvisorMatch can connect you with a CFP® professional to help you achieve your financial goals.
