Cryptocurrency Taxes & Unwanted Financial Holes

Concept of different crypto coins

2020 was a roller-coaster ride of a year. Cryptocurrencies skyrocketed in value while the COVID-19 pandemic shook the global economy. Retailers increasingly believe virtual currencies are the future, as evidenced by their willingness to accept currencies like Bitcoin as payment for tangible products. Extremely volatile and somewhat unpredictable, cryptocurrencies can make and break your millionaire status almost instantly. This value makes purchasing big-ticket items increasingly attractive to early investors in these coins.

Few limits exist when it comes to what can be purchased with cryptocurrency. Bitcoin, which reached a high of over $60,000 during the first quarter of 2021, seems to be the virtual currency preferred by most willing to accept cryptocurrency as an alternative form of payment. Would-be homeowners can now pay for extravagant residences with world-class amenities using Bitcoin. Tesla recently announced that it now accepts Bitcoin as payment for its vehicles. Other retailers such as Microsoft, AT&T, and accept Bitcoin as payment too. You can even use Bitcoin to pay for things like airfare and space travel. The sky appears to be the literal limit for the practical applications of virtual currencies, and this is only the beginning.

Before clicking ‘buy with Bitcoin’ or another cryptocurrency, it is important to understand the financial consequences. Cryptocurrencies, although virtual, are assets with an assigned value. They are not treated as foreign currencies for tax purposes. If you purchase something with cryptocurrency, there will be tax considerations you must observe. According to the Internal Revenue Service (IRS), the “sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability.”

In practice, tax liabilities can vary in severity. If you purchase a meal from Starbucks with $10.00 in Bitcoin, the taxes you owe on those $10.00 will likely be negligible. However, if you purchase a $3.7 million home with Bitcoin, your tax bill will likely be much higher. In fact, you will owe taxes on any realized value more than the virtual currency’s fair market value when it was first purchased or mined. The IRS further states that “you must recognize any capital gain or loss on the sale” of virtual currencies. Sales of cryptocurrency are treated as sales of stock and other investment assets.

If you are going to make larger purchases with Bitcoin or other cryptocurrencies, you should have a plan in place to ensure that you do not run afoul of tax laws. For starters, you should keep detailed records from the beginning of your cryptocurrency journey. This includes keeping detailed records of the fair market value of the cryptocurrency when it was purchased or mined and when it was sold or used to make a purchase.

It is wise to discuss your financial situation with a cryptocurrency consultant or an accountant familiar with the tax laws surrounding virtual currencies. A qualified professional can help you understand the intricacies of the tax laws as they relate to you and your specific financial circumstances. More importantly, a qualified professional can help you steer clear of digging yourself into an unwanted financial hole from which you cannot easily climb out.