Do you still or did you own any digital currencies like Bitcoin from 2014? This is a super-important question to ask this tax season given the dramatic rise in the use and ownership of digital currencies such as Bitcoin. There’s more people that have it than most people think. Annette Nellen, Professor and Director of the Graduate Tax Program at San Jose State University said this a couple of weeks ago when we interviewed her in one of our Future of Money videos.
Calculating overall capital gain or loss from digital currencies is without a doubt, a new premium service you can offer as part of your services. This is because determining this can be quite a bit of extra work.
Last year, the IRS issued notice 2014-21, which in effect classified Bitcoin and other digital currencies as a capital asset. The big difference between Bitcoin for example, though, and other capital assets is that it is much much more liquid than most other capital assets are thought to be. In other words, it is bought and sold very frequently.
People are using Bitcoin, the most popular digital currency, every day to buy things such as coffee, meals, and other goods and services. In addition to this, many people are also converting from US dollars into Bitcoin and vice-versa everyday to hopefully profit from trading it as well.
Also, a new tipping phenomenon has been happening over the last year, where, utilizing Bitcoin, people can mention someone contextually and an object, or a dollar amount and that person will receive a tip denominated in Bitcoin for that amount. An example – let’s say someone on Twitter shares a great link, someone can reply to it and say “Great link, have your next drink on me! cc @ChangeTip.” A service called ChangeTip will then send the original composer of the tweet $5 worth of Bitcoin. This service is being used every day on sites in addition to Twitter, such as Facebook, YouTube, and Reddit.
All of these different scenarios where a digital currency like Bitcoin is being used are potential reportable events since it is a capital asset. As such, the acquiring price and redemption price must be documented. Furthermore, rather than using a Schedule D, it must be reported on Form 8949. This is an especially important factor to note, as utilizing a Schedule D to report Bitcoin transactions WITHOUT Form 8949 would be out of compliance and not provide the level of detail requested by the IRS for declaring digital currency transactions.
Most Bitcoin users are somewhat active, with a combination of many of the above transaction types. Since in almost all scenarios the acquiring price and redemption prices of Bitcoin are not the same, you will need to rely on a few different cost-basis methods to determine a potential capital gain or loss – FIFO, LIFO, or Selective (we call this last method, “Libra Optimized”).
So yes, this is quite a bit of work – but that was until we made LibraTax. LibraTax will automatically import any and all of your client’s Bitcoin transactions, after which you can choose any one of the above cost-basis methods. LibraTax takes what amounts to a potentially hours or even days worth of work and condenses it to minutes. Afterward, we’ll even automatically prepare IRS Form 8949 to include with the return for you.