This is Part Six in a Seven Part Series Covering Taxation of Bitcoin for US Citizens
Written by Tyson Cross a Tax Attorney based in San Diego
Part One – Tax Realization of Bitcoin Gains
Part Two – Tax Recognition of Bitcoin Gains
Part Three- Tax Character of Bitcoin Gains
Part Four – Tax Losses and Bitcoin
Part Five- Tax Deductions Related to Bitcoin
Part Six- Tax Record Keeping related to Bitcoin You are Here
Part Seven- Bitcoin Foreign Account Reporting Requirements
#25: What kinds of records should I keep?
You are required to maintain records sufficient for determining the amount of your gain or loss, as well as the holding period of your bitcoins. This is a flexible standard and depends on the circumstances. Ideally, you should maintain a log of all your bitcoin acquisitions and dispositions, including the price, date, and wallet address of each transaction. Many exchanges make this information available to you in the form of a downloadable spreadsheet. Your log will need to be more detailed if you buy/sell goods with bitcoins and should reflect the items exchanged and their FMV.
#26: How long should I keep my records?
The IRS can generally go back and audit your tax returns for a period of 3 years. That period is extended to 6 years if your tax return omitted more than 25% of your income. Finally, there is no time limit if you are charged with civil fraud or never filed your tax returns. Thus, it is advisable that you save your records for at least three years after filing your tax return, although you might consider keeping them at least six years to be safe.
#27: What if I don’t maintain records?
You are required by law to maintain records, so failing to do so will result in civil penalties if you are subsequently audited and owe additional tax. This means that if you have no records of your bitcoin purchases/acquisitions, you might consider claiming a zero basis and characterize your gains as short-term if you want to avoid penalties. This makes sure that you’ve paid the maximum amount of tax possible on your gains, and therefore there is nothing to which a penalty can attach.
Penalties aside, it is in your best interest to maintain records because the burden is on you to prove your basis. Thus, if you cannot reasonably establish your purchase price, the IRS will assume it is zero. The same goes for holding period (which would cause you to lose the benefit of the lower long term capital gains rate).
This assumption can be disastrous if you engage in a lot of bitcoin transactions. For example, consider a day trader who buys $2,000 worth of bitcoins after seeing a specific market signal, which he then sells shortly after for a small profit of $100. He does this once per day. If he is subsequently audited and lacks the necessary documentation to prove his basis, the IRS will assume it was zero. Thus, he would be taxable on $2,100 of gain every single day, instead of just $100. That is a total taxable gain of $766,500 for the year; compared to $36,500if he had kept adequate records. In addition, he would be subject to penalties on top of the additional tax.
Continue to Part 7 Bitcoin and Foreign Account Reporting Requirements