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Capital Gains & Losses (Part 1)

Introduction

Hey everyone!

This post marks the first in a series of informative U.S. tax posts. The goal of these posts will be to provide awareness to the current state of U.S. tax regulation. We, the authors, will attempt to write the information in an easy-to-understand format. Keep in mind, this will not solely cover cryptocurrency taxation, but all U.S. tax regulation. This being said, the early focus of these posts will cover topics closely intertwined with cryptocurrency.

In any posts relating to cryptocurrency, we will explain the current treatment as per the Internal Revenue Code (IRC) as well as sometimes touching on the proposed treatment, suggested by the American Institute of Certified Public Accountants (AICPA).

It is our hope that these posts will spark productive conversation and lead to fairer tax legislation. Remember, arguing is promoted, but please remain civil!

Throughout a series of posts, we hope to cover the following:

Key Vocabulary for Understanding Capital Gains/Losses
What are Capital Gains/Losses?
What is a Carryforward/Carryback?
What Events Initiate Gain/Loss Recognition?
What Inventory-Costing Methods are Allowed?

Key Vocabulary

Cost Basis – The cost basis is used to establish gain and losses. The basis is the amount the property was acquired for or amount of the property previously taxed (i.e. I buy Bitcoin at $1 and sell it for $10, the $1 is my cost basis). Secondly, if Bitcoin is mined when it is worth $10, that $10 is considered ordinary income at the time the mining was completed requiring immediate tax recognition and, as a result, establishing a cost basis of $1).
Holding Period – This is the length of time property is held.
Long-Term Holding – This is defined by a holding time of greater than 1 year.
Short-Term Holding – This is defined by a holding period of 1 year or less.
First-In-First-Out (FIFO) – An inventory identification method, it assumes that the first assets purchased are the first assets sold.
Last-In-Last-Out (LIFO) – An inventory identification method, it assumes that the last assets purchased are the first assets sold.
Specific Identification Method – An inventory identification method, it directly identifies the asset sold, there are no assumptions. This is generally what is used for high-value, large inventory (i.e. cars).

What are Capital Gains/Losses?

Today’s subject – gains/losses – is extremely important in the cryptosphere. The IRS has concluded that all cryptocurrencies are to be treated as property and, as a result, are subject to capital gains/loss treatment – reported on form 8949. Capital gains and losses are different from ordinary income/losses in that they mark the recognition of previously deferred passive income.

When an individual sells an appreciated asset, the income generated from the sale is considered a capital gain. However, if the asset is still held by the investor, even when appreciation of value exists, no gain is recognized, thus the deferral.

On the contrary, when an individual sells a depreciated asset, the loss generated from the sale is considered a capital loss. These losses offset capital gains and up to $3,000 dollars of ordinary income per year (including the current year). These losses can be carried forward to future years indefinitely to offset future capital gains (and, again, $3,000 of ordinary income per year) – we will go into more depth in section Capital Loss Carryforward/Carrybacks.

Before calculating these gains and losses, however, it is imperative to establish whether they are long-term or short-term (defined above in Key Vocabulary). The individual must first net long-term gains with long-term losses and short-term gains with short-term losses, if there is an excess of losses from either pool, it would carry over into the opposite pool to offset the gains. After the net long-term and short-term gains are derived, you can then establish the tax liability associated with the asset sales.

Keep in mind, long-term gains are subject to preferential treatment, while short-term gains are taxed at the taxpayer’s ordinary tax rates. Long-term gains are taxed at 0%, 15%, and 20%, while short-term gains, on the other hand, cap at 37%. As you can probably tell, one generally prefers long-term gains.

After all of this information, an example is probably in order. Thus, please read on to see an applicable example (keep in mind, all numbers are arbitrary):

Case Facts:

Purchased 1 Bitcoin at $10 five years ago and sold it for $500 in the current year.
Purchased 1 EOS at $8 five months ago and sold it for $4 in the current year.
Purchased 1 share of Alphabet, Inc. stock at $50 eleven months ago and sold it for $40 in the current year.
Purchased 1 share of Coca-Cola, Co. stock at $20 two years ago and sold it for $40 in the current year.

Case Questions & Answers:

What is the cost basis for each token/coin/stock?
1. Bitcoin Cost Basis = $10
2. EOS Cost Basis = $8
3. Alphabet, Inc. Cost Basis = $50
4. Coca-Cola, Co. Cost Basis = $20
What is the holding classification (long-term or short-term) for each token/coin/stock?
1. Bitcoin = Long-term
2. EOS = Short-term
3. Alphabet, Inc. = Short-term
4. Coca-Cola, Co. = Long-term
What is the total gross long-term gain/loss?
- Long-Term Gain = $510 (Explanation Below)
  - (Current FMV Bitcoin - Initial FMV Bitcoin) + (Current FMV Coca-Cola - Initial FMV Coca-Cola)
  - ($500 – $10) + ($40 – $20)
What is the total gross short-term gain/loss?
- Short-Term Loss = $14 (Explanation Below)
  - (Current FMV EOS - Initial FMV EOS) + (Current FMV Alphabet, Inc. - Initial FMV Alphabet, Inc.)
  - ($4 – $8) + ($40 – $50)
What is the total net taxable long-term gain/loss?
- Long-Term Gain = $496 (Explanation Below)
  - (Total Long-Term Gain - Total Short-Term Loss)
  - ($510 – $14)
What is the total net taxable short-term gain?
- Short-Term Gain = $0 (There was a gross loss, which was used to offset the Long-Term gains)

Conclusion

This concludes Part 1 of the Capital Gains/Losses series. Hopefully after reading this you have a general understanding of how to calculated your capital gains and losses when a taxable event occurs. Please don't hesitate to comment below with any questions or input that you may have and make sure to follow the @met account and stay tuned for Part 2 of the Capital Gains/Losses series, where we will continue to discuss how U.S. Tax law handles capital gains and losses.

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About the Author

I hold a Master’s degree in Accounting with a concentration in Information Management. This degree has given me years of exposure to topics, as it relates to the USA, such as: financial reporting, financial statement audits, information systems audits, tax regulation, business law, and overall general business knowledge. Shortly after obtaining my degree I worked for a large public accounting firm for about a year, focusing on IT audits, only deciding to leave to put more focus on cryptocurrency.

While I am not technically a Certified Public Accountant (CPA), I have met the educational requirements and passed all four sections of the CPA on the first try; the only requirement left is to obtain the required experience hours, which I am extremely close to. All of this being said, I can safely say that I am well versed in business knowledge and am more than capable of learning business related concepts.

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Keeping You Safe from the IRS: U.S. Tax 101 (Blog #1) - Capital Gains & Losses (Part 1)