How to Report Bitcoin Earnings (or Losses) on Your Taxes

This year, the virtual currency Bitcoin made headlines due to its massive valuations and volatility. Prices skyrocketed to close to $20,000 from less than $1,000 last year. Companies such as Overstock.com began accepting the cryptocurrency as payment and some companies even began to pay their employees with Bitcoin.

Regardless of how you are participating in the cryptocurrency exchange -- buying and selling, purchasing goods or getting paid -- one consideration to keep in mind is how you will report it when you file your taxes.

[See: Answers to 7 Burning Tax Questions.]

Before the Internal Revenue Service implemented regulations on virtual currency such as Bitcoin, the taxation of income or losses generated from the exchange of Bitcoin was up in the air. But in 2014, the IRS issued guidance and answered the question about how the currency should be taxed.

The IRS announced that virtual digital currency such as Bitcoin should be treated as property instead of currency for federal tax purposes. This means that the same rules that apply to property transactions, such as the sale of stocks, apply to virtual currency. Additionally, how the virtual currency is used also impacts how it is taxed.

There are a few common scenarios seen in the exchange of Bitcoin. If the purchased cryptocurrency is held as an investment and sold, it is taxed as property. If it is used to pay for goods or services, it is taxed as income to the person receiving the Bitcoin. If it is mined, it is taxed as income.

[See: 10 Smart Ways to Spend Your Tax Refund.]

Cryptocurrency held as a capital asset is taxed as property. If you are holding virtual currency such as Bitcoin as a capital asset, you treat it as property for tax purposes, the same way you'd treat a stock or bond. This means that if you are holding on to virtual currency, but haven't sold it, then you don't have to report it on your taxes. However, when you sell or exchange Bitcoin, you have to report the gain or loss on your taxes, just like any other capital asset.

Cryptocurrency received for goods and services is taxed as income. If you were paid your wages in Bitcoin by your employer, it will be taxed as income and it should be reported on your W-2 as taxable income. The value of what you were paid in Bitcoin will be taxed at the fair market value and subject to income and payroll tax withholding.

Independent contractors who receive virtual currency for performing services have to include the fair market value in self-employment income, and that income is subject to self-employment tax. The fair market value of the Bitcoin you received for services should be reported on Form 1099-Misc by the person who pays you.

[See: 7 Most-Missed Tax Deductions and Credits.]

Cryptocurrency miners must report receipt of the virtual currency as income. The trickiest situation occurs when people are mining Bitcoin. This is when you use computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger. It is also the process by which cryptocurrencies like Bitcoin are created. In this situation, although you are technically not buying or selling it, you still have to report it on your taxes.

According to the IRS, when a taxpayer successfully mines cryptocurrency and has earnings from that activity, he or she must include it in gross income after determining the fair market dollar value of the virtual currency as of the day it was received.

If you are considering buying or selling cryptocurrency, just follow this rule: How you use it relates to how it is taxed. If you keep good tax records and keep in mind how you are using the currency, understanding the tax implications will be a breeze.

Lisa Greene-Lewis is a certified public accountant and TurboTax tax expert. She has more than 15 years of experience in tax preparation, including positions as a public auditor, controller and operations manager.