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What cryptocurrency investors need to know about their gains and their tax liability

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For most people, cryptocurrency taxes are often an afterthought, with some newer investors not even realizing that their gains are taxable.

The general unawareness of tax liability among the general public has actually persisted for quite some time now, despite cryptocurrency-related websites and communities often attempting to educate such first-time investors.

A user on Reddit, for instance, posted on the website’s ‘personalfinance’ discussion board, stating that he had forgotten about his tax liability when he sold his holdings in Dec. 2017. Given the meteoric rise in price that bitcoin enjoyed throughout the past year, he was able to amass a huge amount of profit on the sale.

However, instead of setting aside a percentage of his earnings for taxes, he immediately reinvested the entire amount into other altcoins. Now that the market has declined by 60 percent in 2018, he may be forced to sell his position at a loss to pay the IRS $50,000 in taxes.

In most countries, including the U.S., cryptocurrencies are treated as assets that can appreciate or depreciate in value. As a result, the rule that applies to them is not akin to traditional currencies, but property instead. When an individual sells part of his holdings, the sale is treated as a taxable event. Taxes, however, are not incurred when the cryptocurrency is bought, only sold.

It is important to note that the recent spike in cryptocurrency popularity has prompted the United States Internal Revenue Service to keep a close eye on individuals that made considerable gains on their bitcoin investments.

In Nov. 2017, the IRS demanded that the U.S. based cryptocurrency exchange, Coinbase, release details on as many as 13,000 customers. The IRS requested data on users linked to high-volume bitcoin trade between the years 2013 and 2015, and more specifically, individuals that had completed transactions of over $20,000 in a single year.

While several online services claim to offer guidance with cryptocurrency-specific tax filing, most individuals will probably be better off either hiring a tax agent or assessing their liability themselves.

On the topic of digital asset taxation, a CNBC article states, “If you’ve seen a large increase in wealth in a calendar year, from cryptocurrency gains or the appreciation of other assets, set a portion of it aside in anticipation of tax payments.”

In the event that the IRS or any other country’s tax authority discovers undisclosed capital gains, the individual will most likely be liable to pay penalties depending on the severity of the offense and the time passed since the deadline. Once the tax filing and payment deadline has passed for a financial year, the U.S. IRS has the ability to collect additional penalties every month on any unpaid dues.

The first, failure-to-file penalty, is five percent of the unpaid tax amount, whereas the failure-to-pay penalty is another half a percent on top of that.

The simplest way for investors to avoid legal or financial trouble from the IRS is to maintain a record of all cryptocurrency-related trades that they have participated in within a financial year. Not only will doing so make filing a relatively hassle-free process but can also be used to determine the investment’s cost basis at the time of purchase.

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