Taxpayer asks:

I paid short term and long term capital gains on my Bitcoin when I moved it from Coinbase into my hardwallet. Do you see any reason I should have to pay more taxes again when I spend some of these same Bitcoins from my hardwallet? Thanks.

Taxgirl says:

This is a great question. Guidance on the tax treatment of cryptocurrency has been limited (and late in coming), so there’s still a lot of confusion.

Some background might be helpful. In 2014, the Internal Revenue Service (IRS) issued guidance to taxpayers (downloads as a PDF), making it clear that virtual currency will be treated as a capital asset, provided they are convertible into cash. In simple terms, this means that capital gains rules apply to any gains or losses. 

That means, generally:

  • For those taxpayers buying and selling cryptocurrency as an investment, calculating gains and losses are figured the same as buying and selling stock. That’s true, as well, when it comes to basis, holding period and a triggering (taxable) event.
  • For those treating cryptocurrency like cash – spending it directly for goods or services, or using it to buy other cryptocurrencies – the individual transactions may also result in a gain or a loss.

In your case, the trick is to figure the triggering (taxable) event. A taxable event is typically a sale or disposition of an asset. When it comes to cryptocurrency, a taxable event typically occurs whenever the crypto is traded for cash or other crypto or whenever the crypto is used to purchase goods or services.

It’s also true that cashing cryptocurrency out of an exchange or similar platform may be treated as a sale – even if you’re forced to withdraw it. It sounds like that’s what you did. You moved Bitcoin from one platform to another and paid the resulting tax on the gain. 

But you’re not done yet. When you spend your Bitcoin, you may be subject to tax again. That’s because you’ve experienced another triggering (taxable) event. The good news is that your basis will be adjusted accordingly.

Here’s an example.

Let’s say that you bought Bitcoin for $100, and when you moved it, it was worth $300. The gain was $200, and you paid tax on the gain.

Let’s assume that your Bitcoin are worth $350 when you’re ready to spend it. You will pay capital gains tax again – but using a new basis based on the value of the move from your last transaction.

So, in the first instance, it’s $300 (move price) – $100 (original cost) = $200 of gain. In the second instance, it’s $350 (value at the time you spent it) – $300 (new basis) = $50 of gain. All totaled, you have $250 in gain spread out over time. It’s the same result as though you held onto it for the entire time: $350 (value at the time you spent it) – $100 (original cost) = $250.

But what if it had gone south? Let’s say it was only worth $150 when you spent it. Then:

$150 (value at the time you spent it) – $300 (new basis) = -150 (you have loss).

You can claim up to $3,000 (or $1,500 if you are married filing separately) of capital losses and the amount of your loss offsets your taxable income for the tax year. If your losses exceed those limits, you can carry the loss forward to later years subject to certain limitations and restrictions.

Capital gains tax rates are generally favorable.

Capital gains rates for long term gains (those held more than a year) range from 0% to 20% while short-term capital gains are taxed as ordinary income.

You’ll report all of your realized gains and losses on Schedule D. You don’t file a Schedule D if you don’t have any realized gains or losses: even if the value changes, if there’s no sale or disposition, there’s nothing to report.

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

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Author

Kelly Erb is a tax attorney and tax writer.

4 Comments

    • Kelly Reply

      I agree that there should not be a tax consequence from the initial move, but some platforms are treating moves as a sale (since they can’t track it after it’s out of the account). If that happens – as it looks like was the case here – you may be better off paying the tax than opening your account up for scrutiny (as always, check with your tax pro). I suspect, as with stocks and bonds, this will improve with better reporting.

      And thanks to the link to the FAQs, always a good idea!

    • Hey Annette: You are 100% correct about how a transfer of BTC from an exchange to a wallet is NOT a sale, and it shouldn’t be reported as such on Schedule D. As long as the BTC does not change character (i.e., it wasn’t exchanged for another crypto, like ETH or XRP, or sold into a fiat currency) at the time of the transfer, it is NOT a sale.

      Kelly: I see your point about the scrutiny, but I’d honestly rather save my client money by not reporting gain that didn’t happen. Tax pros in this space understand that there are sometimes issues with the data that the exchanges report, so we request super-detailed crypto exchange records from the client when we are reconciling their crypto activity. We can even back those up with traditional bank records to track fiat deposits and withdrawals into exchanges, if needed. And if we really need to prove that a sale DIDN’T happen (only a transfer), we can go to the ultimate authority: the blockchain. That beautiful distributed ledger tracks every detail of every transaction. Personally, I believe that crypto reconciliation done right can withstand IRS scrutiny. Just follow the money (yes, it’s time consuming–that’s why I charge accordingly). Plus, most of my clients in the space already know that the IRS hired Chainanalysis to examine the blockchain; they understand that they’re likely to experience scrutiny no matter how cautious they are in reporting their sales. 🙂

      • Kelly Reply

        Thanks Gisele. To be clear, I’m not advocating paying the tax at the transfer *just* to avoid scrutiny. I’m suggesting that if the platform is treating it as a sale, I don’t know how much I’d push back. It would depend on circumstances like the amount due, the taxpayer’s overall involvement with crypto and – this is important – what’s showing up on other schedules, like Schedule C, since the IRS could examine the entire return. I don’t like opening a return up to scrutiny unless there’s a real benefit to the taxpayer. As you referenced, it can be expensive, so for me, the overall savings should make sense (nobody wants to pay a huge accounting/tax bill to save a couple of hundred dollars in tax).

        In this case, it’s also worth noting that the taxpayer had already paid the tax on the transfer.

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