Despite the fact that Bitcoin was introduced more than a decade ago, there is still a lot of misinformation about its taxes. Cryptocurrencies were intended to be a daily transaction medium, but it has yet to gain popularity. Meanwhile, due to the volatility of Bitcoin’s price, it has increased in popularity among speculators and traders trying to profit from it.
With the Internal Revenue Service (IRS) classifying Bitcoins as assets, Bitcoin transactions are subject to various taxes depending on the type of transaction. Even so, there’s a few exceptions due to Bitcoin’s value, characteristics, and applications. In this article, we’ll look at how to invest in Bitcoin while keeping taxes in mind.
Essential Steps for Investing in Bitcoin
For most investors, the most convenient way to purchase Bitcoin or a known Bitcoin price is through a brokerage account or a cryptocurrency exchange account. Most digital wallets can also be used to purchase Bitcoin; however, for the purposes of this section, we’ll concentrate on the simplest method:
- Select the right Bitcoin exchange or brokerage for you:
Before you begin your Bitcoin transaction, decide where you want to get and keep your digital money. While trying to decide where and how to buy Bitcoin, keep fees and the notoriety of the exchange in mind, as these can affect the Bitcoin amount you pay. Also, confirm that the functionality you need to use to transfer your Bitcoin out of the investment account is available, as not all brokerages do.
- Create a Bitcoin-friendly account:
After you’ve decided on the ideal account, it’s time to open your brokerage or cryptocurrency account. If you live in the United States, submit your basic contact details and acceptable identity to meet the exchanges know your customer (KYC) guidelines.
- Fund your account:
After you’ve opened your account, it’s time to fund it. The quickest and cheapest method is usually an online funds transfer from a linked bank account. Depending on your exchange, you may also be able to use payment apps. Some digital currencies allow you to trade right away, while others require you to wait for the funds to clear before making a purchase. If you can purchase cryptocurrencies immediately, you may have to wait for the deposit to clear before withdrawing funds from your account.
- Fill out a purchase order:
To buy Bitcoin, click the buy button when you believe the Bitcoin price and the time are right for you to invest. The exchange will convert your dollars to Bitcoin, which will be stored in the same cryptocurrency account as your stocks. When your transaction is completed, you will be the proud owner of Bitcoin.
Bitcoin Taxes to Take into Consideration Before Investing
The classification of bitcoin as an asset clarifies its tax implications. The IRS has passed a law requiring for all bitcoin exchanges, regardless of its size, to be disclosed by taxpayers. Every taxpayer in the United States is required to keep a record of all Bitcoin purchases, sales, investments, and usage. In July 2019, the IRS issued warning letters to over 10,000 taxpayers for “possibly failing to declare income and pay the resulting tax from virtual currency transactions or failure to properly notify their transactions.” It warned that failing to declare income correctly could result in fines, interest, or even criminal charges.
Which Bitcoin transactions are subject to taxation?
Taxation applies to the following types of Bitcoin transactions:
- Bitcoin you mined yourself and sold to a third party: For example, if you mine Bitcoin and profitably sell it to another person, you must pay capital gains taxes on the transaction.
- Bitcoins purchased from a third party and sold to another party: If you buy Bitcoin from a cryptocurrency exchange or another individual and subsequently sell it for a profit, you must pay capital gains taxes on the transaction.
- Purchasing goods or services with mined Bitcoins: If you buy coffee using Bitcoin that you mined at home, for example, the transaction necessitates the payment of capital gains taxes. (The tax amount is determined by the characteristics of the transaction, such as the Bitcoin price at the time of sale and the price of coffee.)
- Purchasing products and services with Bitcoin brought from someone:
If you transfer Bitcoin from an exchange to your own wallet and use it to buy something, you will be taxed on the capital gains.
- Deducting expenses incurred throughout the mining process:
The first and third scenarios are taxable as personal or business income, respectively. The second and fourth scenarios are more akin to asset investments.