Ripple. Ethereum. Litecoin. Dash. Monero. And the oh so famous Bitcoin. All of these are different cryptocurrencies which recently have been all the rage among investors, and with their extreme volatility, their future is constantly in question.
What is Cryptocurrency
Now for those who don’t know, cryptocurrency is a form of digital money designed to be secure and anonymous and allows users to make payments without having to go through banks. It uses cryptography, a process used to convert legible information into almost uncrackable code, to track its purchases and transfers.
While different forms of digital currency have been around since the 1990s, most of them failed. Cryptocurrency has only been around since 2009, when Bitcoin was invented. Since then the cryptocurrency market has ballooned and there are more than 900 currencies that are currently active.
Thus far, cryptocurrencies are not regulated by any major governing body, making their value fluctuate based off of supply and demand economics. This has also led to their being banned in several countries, including South Korea and China.
Now if you’re worried about how section 1031 issues will affect you and your cryptocurrency, they probably don’t apply to you, and we will be covering them in a future article.
How are Cryptocurrencies taxed
Many individuals are treating cryptocurrencies as they would general stocks, through adding and removing legal currency from the exchanges. There are really two scenarios that can occur; your income will either be taxed as standard income or it’ll be taxed as capital gains income.
Let’s say that you purchased 1,000 Bitcoins in December of 2010 for $0.25 each. You forgot about the purchase until December of 2017 when Bitcoin was value at $19,000 and you chose to sell it making about a cool $19,000,000. Because you have held Bitcoin for over a year your gain is taxed at a Capital Gain tax rate of 20%, meaning that your tax bill sits at around $3.8 million prior to counting in the taxes on your ordinary income.
Now if you weren’t one of the few who purchased it in 2010, and instead you purchased 1,000 Bitcoin in January of 2017 for $775 each. Instead of hanging on to it you also choose to sell it in December of 2017 when the value was at $19,000 so you are grossing $18,225,000. However, because you haven’t held the investment for at least one year, it will be taxed at the same rate of ordinary income, meaning that it will be hit at the top tax bracket of 39.6% before factoring in state income tax as well.
From a tax perspective if you are dealing with high value investments it is always better to hang on to them for over a year so that you are paying Capital gains tax rather than federal and state income tax. If you have any other questions about how cryptocurrency will affect your tax bill contact us at GROCO today.