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Should you pay taxes on your digital currency?

Tax time is fast approaching and many people are starting to think about what they will report on their 2018 return.

If you invested in digital currency last year, you may be wondering how to handle it on your return. That may depend, in large part, on how you used your cryptocurrency. 

Cryptocurrency as property

The IRS defines all digital currency as property. Therefore, any exchange of cryptocurrency is taxable, even if there is no fiat currency involved. The IRS considers the following actions a taxable exchange:

  • Trading from one digital currency to another
  • Using cryptocurrency to pay for goods and services
  • Trading cryptocurrency for the US dollar (fiat currency)

You will have to calculate capital gains or losses on any of these transactions. You may, however, buy cryptocurrency, conduct a wallet-to-wallet transfer or gift the cryptocurrency all without triggering a taxable event.

Short-term or long-term capital gains

Many people investing in cryptocurrency have treated it as a short-term investment. That means they sold or traded it within 12 months. Those transactions are subject to short-term capital gains, taxed at income-tax rates.

If you held onto the investment for more than 12 months, you can apply the lower long-term capital gains rate. Those rates have not changed under the new tax act for 2018.

Tips for investors

Reporting your cryptocurrency transactions can become quite complicated, and the rules still have some ambiguous areas. Here are a few tips for managing your transactions:

  • Document every transaction. Although some cryptocurrency exchanges keep documents, you should always keep your own documents. Note the value in U.S. dollars at the time of your exchange, and exactly what you are receiving for your trade.
  • Understand your obligations. Depending on how often you trade, and at what volume, you may have to pay quarterly taxes. Work with a tax professional to find out if you need to pay estimated taxes.
  • Harvest your losses. The crypto market has seen significant losses in 2018. You may be able to offset gains by selling some of your holdings to realize those losses.

Whether you are new to cryptocurrency or heavily invested, the rules can be confusing. The major tax changes for 2018 only make these issues more complicated. When in doubt, obtain professional advice regarding your obligations so you can make the most of your digital investment.

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