Please ensure Javascript is enabled for purposes of website accessibility

Millions of Cryptocurrency Owners Could Be Making a Big Mistake

By Matthew Frankel, CFP® - Updated Feb 14, 2018 at 5:18PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Virtually no Americans are paying taxes on their cryptocurrency profits -- at least not yet.

It's been a slow day for the major cryptocurrencies on Tuesday, with values for bitcoin, Ethereum, Ripple, Bitcoin Cash, and Cardano barely changed over the past 24 hours. After a multiday rally that sent all of the leading cryptocurrencies up by double-digit percentages in the past week, it appears that the market could be running out of steam, at least temporarily.

Despite the quiet on that front, though, there could be trouble on the horizon for many cryptocurrency investors, based on a new Credit Karma study. It appears that few investors are reporting cryptocurrency profits on their 2017 tax returns, which could mean many of those who have made money from them will owe penalties and back taxes down the road.

1040 tax forms with a calculator, an open graph notebook, and black fountain pen on a green background.

Image source: Getty Images.

Today's cryptocurrency prices

First, here's a quick look at the five largest cryptocurrencies by market capitalization and how much each has changed over the past 24 hours.

Cryptocurrency Name (Code)

Price in U.S. Dollars

Day's Change

Bitcoin (BTC)

$8.689.30

(1.6%)

Ethereum (ETH)

$846.83

(2.6%)

Ripple (XRP)

$1.00

(2.9%)

Bitcoin Cash (BCH)

$1,242.60

(2.4%)

Cardano (ADA)

$0.37

0.7%

Data source: www.investing.com. Prices and daily changes as of 3:30 p.m. EST on Feb. 13, 2018, and prices are rounded to the nearest cent where appropriate.

Few investors are paying cryptocurrency taxes

Bitcoin's value increased more than tenfold in 2017, and many other cryptocurrencies performed even better. According to estimates, about 7% of Americans own cryptocurrencies, and a recent Credit Karma survey found that 57% of cryptocurrency owners have realized gains on their investments. So, it's safe to assume that a significant number of investors have made a profit from them.

However, you wouldn't know that based on their tax returns. Fewer than 100 out of 250,000 Americans who have filed taxes using Credit Karma have reported any taxable cryptocurrency gains for 2017. That's a rate of less than 0.04%. What's more, only one person out of the quarter-million tax returns disclosed a "significant" gain or loss.

To be fair, people with large capital gains who expect to owe money tend to file later in the season, so I expect an uptick in the number of returns with cryptocurrency profits as we get closer to the April tax deadline. Even so, 0.04% is an alarmingly low rate.

Crypto profits are capital gains

If you made any profits on the sale of cryptocurrencies, it's important to realize that they are considered to be capital gains for tax purposes. In other words, they are governed by the same tax rules that apply if you had sold stock for a profit.

Long-term capital gains -- if you held your cryptocurrency for over a year -- are taxed at more favorable rates, while short-term gains are taxed as ordinary income. For example, someone who bought bitcoin and sold it a few months later at a $10,000 profit, and is in the 25% federal income tax bracket for 2017, would owe the IRS $2,500.

Don't mess with the IRS

Finally, it's also important to realize that the IRS knows that there's money being made in cryptocurrencies, and is taking steps to come after people who don't pay taxes on their gains. Last year, for example, it sued Coinbase for access to customer records after only about 800 people reported any bitcoin gains or losses in 2015.

The IRS can and will come after people who made money on cryptocurrencies in 2017, and will not only send a bill for taxes due but can assess penalties and interest for underpayment of tax.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
330%
 
S&P 500 Returns
115%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/22/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.