Calculating capital gains and taxes for Bitcoin and other crypto-currencies
Knowing how taxes play a role in your bottom line is key to realizing all the benefits of dedicating your expensive hardware to secure a decentralized cryptocurrency network.
Net earnings in self-employment is equal to gross income from trade or business, less allowable deductions. Individuals generally work as employee or independent contractor. On behalf of their employees, employers account for, and collect via payroll employment taxes. Individuals work as independent contractors and account for their own taxes.
If you mined your bitcoins, as IRS Notice elaborates, miners have to recognize income for each bitcoin mined during the taxable year. The IRS illustrates an example for taxpayers. Instead, they would be deductible in the taxable year as an expense. Miners will need to determine if their mining activity rises to the level of a trade or business, which is a highly factual determination. If your mining operation is not substantial or continuous, you would deduct expenses like an ordinary investor.
Adding your gains and losses will reduce your total gains and so reduce the amount of taxes you will pay. You need to be aware that first, you combine your long-term gains and losses, then short-term gains and losses, and finally arrive at your net gain or loss. Any remaining losses can be carried forward into future years. Wash Sales At the tax end year, you might think to sell stocks that have fallen in price, buy them back, just to create a loss and report it in your taxes. You’ll have capital losses, pay less taxes and could buy those stocks back again at a very similar price.
This is known as tax-loss selling and the IRS prevents it by their wash sale rule. A sale is deemed to be a wash if you buy the same, or similar, stock or security within 30 days before or after a loss sale.
If a sale is a wash, then you cannot claim those losses but instead they are transferred to the cost basis of the related purchase. The tax code defines wash sales as only applying to stocks and securities, which Bitcoin is neither: A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale [ IRS p17 ] That’s not to say they should be allowed, but since Bitcoins are property they do not fall under this rule.
Economic Substance However, there is more to it than this, something called the “economic substance doctrine”. This says that a transaction must have economic substance apart from just tax effects.