1. Bitcoin Tax Guide: An Introduction
  2. Bitcoin Tax Guide: Trading Gains And Losses - Fair Market Value
  3. Bitcoin Tax Guide: Trading Gains And Losses - Alt-Currencies
  4. Bitcoin Tax Guide: Trading Gains And Losses - LIFO, FIFO, Offsetting Lots
  5. Bitcoin Tax Guide: Trading Gains And Losses - Wash Sales: Impossible To Track?
  6. Bitcoin Tax Guide: E-commerce Taxation
  7. Bitcoin Tax Guide: Donations
  8. Bitcoin Tax Guide: Gifts And Tips
  9. Bitcoin Tax Guide: Lost Or Stolen Bitcoins

Things get even more complicated from both a reporting and enforcement standpoint, once you consider that traders have the right to calculate their cost bases using different methodologies. Since Bitcoin is now taxed as personal property, like shares of stock, investors theoretically have the option to sell their assets on a first-in-first-out (FIFO) basis, a last-in-first-out (LIFO) basis, or to sell those specific tax lots that are most efficient under the "specific share identification" method used for stocks.

The choice of cost basis can have a significant effect on long-term and short-term capital gains calculations.

Suppose over a two-year period, Joe (who you'll recall is in the 25% income-tax bracket) made the following Bitcoin purchases:

Lot Date

BTC

Cost Basis

Price Now

Gain (Loss)

Oct. 2012

100

$10

$750

$74,000

Sept. 2013

40

$150

$750

$24,000

Nov. 2013

20

$900

$750

($3,000)

Now, suppose that Joe wanted to sell 60 bitcoins in December 2013 because he got skittish once China cracked down on Bitcoin adoption. He could choose to sell his longest-held bitcoins (FIFO method) from October 2012 to benefit from lower long-term capital gains rates of 15%. Or he could sell his shortest-held bitcoins (LIFO method) from September and November 2013 to realize a lower nominal gain ($5,250 vs. $6,660).

Method

FIFO

LIFO

Specific ID

Lots Sold

Sell 60 BTC from Oct. 2012

Sell 20 BTC from Nov. 2013

Sell 40 BTC from Sept. 2013

Sell 20 BTC from Nov. 2013

Sell 40 BTC from Oct. 2012

Tax Result

LT Gain: Oct. 2012

(60%*$74,000*15%)

ST Gain: Sept. 2013, Nov. 2013

($30,000*25% - $1500*25%)

LT Gain: Oct. 2012, ST Gain: Nov. 2013

(50%*$74,000*15% - $1500*25%)

Taxes Due

$6,660

$5,250

$3,690

Today's trading platforms may automatically incorporate FIFO or LIFO methods for their clients; however, neither is the most tax-friendly way for Joe to track his cost basis. Instead, Joe might prefer to sell the 20 bitcoins he bought in November for a tax advantage of a $3,000 write-off to his ordinary income for 2013, and sell the remaining 40 bitcoins from the October 2012 lot to realize a smaller long-term capital gain. The result would be nearly $3,000 in tax savings - over two full weeks of Joe's take-home pay - for a simple and legal change in his personal trade accounting.

In real life, "specific identification" sub-accounting may be out of Joe's hands or outright impossible. Even the industry's leading exchanges and hosted wallets currently lack the accounting software needed to ensure trades are executed in a tax-optimizing fashion. After all, this type of sale only works if you can tell your "brokerage" exactly which units you would like to sell. Yet since Bitcoin is a divisible and fungible virtual currency, any new transaction would need to be carefully time-stamped to track which specific Bitcoin "lots" Joe intended to sell from his investment account. If Joe uses a Coinbase account with 25 different wallet addresses that is later combined into a single wallet, he may be at the mercy of Coinbase with respect to the sequence in which his bitcoins are liquidated during the sales process.

If professional exchanges have trouble with this sub-accounting, imagine the complexity for individuals who must track their own sales! And think of the unnecessary tax liabilities active traders may incur!

Bitcoin Tax Guide: Trading Gains And Losses - Wash Sales: Impossible To Track?

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