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just one more geek in a sea of austin techies

February 6, 2021

PayPal, Bitcoin and Taxes (oh, my!) #CryptoGeek

Over the past year, PayPal's stock value has surged considerably along with many others in the online payments processing realm.  Indeed, prior to 2020 PayPal had already solidly established itself as the fourth-largest payments processor behind Visa, Mastercard and Discover.  PayPal is now the largest of all pure-digital payments processors with more currently-active PayPal accounts than the entire population of the United States.  
 
If this weren't already enough, in 2020 PayPal decided to go "all-in" on Cryptocurrencies like Bitcoin, Ethereum, and Litecoin.  You can now easily buy and sell Cryptocurrencies (a.k.a., "crypto") with a standard (free) PayPal account.  This move by PayPal brings crypto accessibility to the masses more than anything has before.  However, the masses are largely not up to speed with how crypto is different from typical currency and, perhaps more importantly, how spending crypto can have a major impact on taxes for US citizens.

The short version: 

  • Treat crypto like stocks, not money.
  • Every crypto transaction has end-of-year tax implications.
  • It is super-easy to get into crypto with a (free) PayPal account.  
  • You can quickly make or lose lots of money with crypto.

The long version: 
Read on...

 

Get rich with crypto? Yes, that's very possible.
First, let's get this out of the way:  Yes, you can potentially make lots and lots of money from Cryptocurrencies.  
Investing in crypto is very much a gamble, not a guarantee.  The more money you have to risk (plus time and patience) the more you have to gain.  

Most cryptocurrencies have value only because people believe they have value, not because the currencies are guaranteed or are backed by any tangible assets.  A proper crypto, just like a proper real-world currency, has limited availability by design in order to enjoy increased value when there is increased demand.  The more that people believe in and want a particular crypto then the more value it has and vice versa.  This dependency on belief goes a long way towards explaining the sometimes-wild fluctuations of crypto values.

That said, the overall crypto trend to date has proven to be very good to patient investors.  

Examples:
Bitcoin is the best-known crypto and has experienced many sizable price jumps and falls over the past decade: 

  • In April, 2011, one Bitcoin was worth $1.  By June, 2011, one Bitcoin was worth $32 -- a fantastic rise of 3200% in just three months.  Before the end of 2011, however, the price plunged to as low as $2.  Depending on when someone bought in they either made an astounding return on their investment or they may have nearly lost it all (assuming they went ahead and sold at $2 but why would anyone have done that?!?)
     
  • In 2013 Bitcoin started around $13 and climbed as high as $1156 before falling a few days later to $760.  Very volatile price fluctuations, indeed!  But also plenty of room to make a profit for those who bought low -- quite the reward for the 2011 investors who stuck it out until 2013.
     
  • In 2017 Bitcoin jumped from $975 to over $20,000.  At the start of the year few people thought $975 was "cheap" but the currency defied logic with a more than 2000% increase in just a few months' time.  Later, though, the value fell to a little over $7,000, until...
     
  • During the pandemic of 2020 and 2021 (which we are still in as of this writing), Bitcoin has climbed as high as $41,500.  As of the date of this posting it trades at $37,880.

As you can see, the value of crypto currencies can vary greatly over short periods of time.  If you have money to risk (read: money you're willing to lose) and are willing to wait out any major downturns, you are a good candidate for dipping a toe into the crypto waters.  If the trend of the past decade continues, investors will likely enjoy a profit by simply waiting long enough to catch a sharp rise in value.  

When you're ready to cash in, crypto (virtual currency) can be exchanged for cash (actual currency).  If you're using a user-friendly exchange like PayPal, cashing in typically only requires a few clicks of the mouse.  Easy!  This is the big difference between 2021 and prior years: trust and ease of access.  For most of the past decade crypto has been relatively complicated to access and use for the average consumer.  An investor would have to garner a certain level of knowledge, find a trusted crypto exchange, and hope that the trusted exchange itself wasn't eventually compromised by hackers.  Stolen cryptocurrency is lost cryptocurrency -- there is no FDIC insurance for crypto.  In the past these concerns were enough to cause a majority of traditional investors to shy away from crypto as a serious investment option.  PayPal's move into crypto is helping to bring easy crypto investment to the masses.


Buy things with crypto?  Oh, yes.  And oh, no...
More and more vendors are allowing customers to make purchases using crypto directly without first having to convert crypto to cash.  This brings Cryptocurrencies even closer to parity with regular currencies.

Most people would be surprised to discover some of the merchants now accepting cryptocurrencies:

  • Microsoft
  • AT&T
  • Subway (the sandwich shop)
  • Burger King
  • Rakuten (formerly BUY.COM)
  • Dish Network
  • Newegg
  • Overstock.com
Even single-location brick-and-mortars are getting in on the crypto scene.  You can spend Bitcoin directly at the MIT student bookstore (oldest college bookstore in the US), Pembury Tavern (a pub) in London, and Helen's Pizza in Jersey City, New Jersey.

PayPal has announced that it intends to begin allowing (at least some) payments to be made with crypto by the end of the first quarter of 2021.  
 
So far PayPal only allows users to buy crypto, hold it, and change it back into cash (hopefully at a profit).  PayPal charges a transaction fee when buying or cashing crypto.  Soon, however, PayPal will allow crypto to be spent directly with selected merchants.  While that will be very cool from a technology standpoint, it needs to be noted that spending crypto is not like spending regular money.  Even if merchants make it easy for consumers to pay with crypto, the US government does not.  
 
To summarize in a word: taxes.


April 15th is approaching.
Do you remember every crypto transaction this past year?

For US citizens, cryptocurrencies have tax implications that regular currency does not.  The IRS categorizes "virtual currency" (crypto) as property rather than as currency.  Any profits realized through the exchange of crypto is treated as capital gains and is subject to capital gains taxes.  Dealing in crypto is strikingly similar to handling stocks where taxes are concerned.

Treat every crypto transaction like buying or selling a stock
Ok, so here's the deal:  If you buy $10 worth of crypto today and the value increases to $30 next week, you can exchange your crypto for $30 cash.  Let's say you decided to exchange only $10 for cash and keep the remaining $20 as crypto.  The $10 you converted to cash would include a "realized" profit of $6.67.  The profit isn't the entire $10 because the $10 cashed out includes a cost of $3.33 -- the original investment cost for the number of crypto "coins" cashed out (which, in this case, is exactly 1/3 the number of coins included in the original $10 crypto purchase).  

The remaining uncashed coins and associated profit is not taxed (yet) because you have not yet "realized" that profit by converting the remaining crypto back to cash.  The IRS only taxes you for profit made on crypto at the time it is turned into something else -- when you cash it out or trade it.

The $10 you took out includes $6.67 profit which itself is subject to the capital gains tax.  Because you took profit on crypto purchased only a week before, this is treated as a short-term gain (less than 1 year) and you'll be subject to a 50% tax.  You'll need to set aside $3.34 of your $6.67 profit for end-of-year taxes (ouch!)

You can see how taxes can quickly start to add up if crypto values increase and you spend (or just convert to cash) that inflated crypto.  The easiest approach to reducing your crypto tax exposure is the same approach you'd employ with stocks: buy and hold.  Once your cypto is at least a year old, you can spend or cash it in at a much-reduced long-term gain tax rate.  How much of a reduced rate depends on your annual income.  For the 2020 tax year the long-term rate is 20% if you make more than $469,050, 15% if you make more than $53,600 but less than $469,050, or 0% if you make less than $53,600.  All of those rates are far better than the short-term capital gains rate of 50% so your plan should always be to hold crypto for at least 12 months before cashing or spending.

While the practice of buy-and-hold is simple, the act of spending crypto is far less so.  The value of crypto is constantly changing, as in every second of every day.  You will need to determine the amount (number of crypto "coins") and the exchange rates at the moment of sale whatever crypto you've spent against the exchange rate at the moment of your original crypto purchaseThis is why using crypto is not as simple as using regular currency no matter how easy businesses may make it to spend crypto.  This is also why many people will have a rude tax awakening either by discovering at tax time that such detailed documentation is required or by overlooking this requirement entirely and falling on the wrong side of the IRS through unreported crypto-related income.  As you might expect, the IRS is keeping a close eye on crypto and has already successfully used legal action to force some crypto exchanges to share transaction records so the IRS could pursue individual investors for related back taxes on unreported profits.  Keeping good records for your crypto transactions is critical!
 

Getting your critical crypto tax info from PayPal
If you have a PayPal account and you've ventured into one or more Cryptocurrencies, there is a way to get the critical info you need for tax reporting.  As of this writing PayPal has not enabled the ability to spend or trade crypto but only to buy crypto for yourself and then exchange what you've bought back for cash.  This simplifies things a bit for the 2020 tax year.

If you've purchased crypto but did not exchange any back for cash during 2020 then you have no tax exposure and nothing to report to the IRS.  You *will* want to get and keep a record of your crypto purchases as you will need that information in the future when you do eventually do something with your crypto.

If you exchanged any crypto back for cash (even a tiny amount) during 2020 then you will need to report this to the IRS.  You should do this even if your crypto experience resulted in a loss as reported losses might help lower your taxes.  To report your profits and/or losses, you'll need PayPal transaction info for each of your crypto transactions involving crypto being bought and subsequently being turned back into cash.  

To get your crypto transaction details:
At the moment PayPal does not appear to offer an adequate exportable report for crypto transactions.  There is an "Activity Download" report that includes crypto transactions but it does not include all necessary details -- namely, it lacks a record of the crypto's exchange rate and the number of "coins" involved in a particular transaction.  Fortunately, though, you can get this additional detail directly from the list of transactions on the "Activity" tab as follows:

  1. Log into PayPal
     
  2. Switch to the "Activity" tab
     
  3. Find your crypto. 
    TIP:  PayPal does not yet offer a filter for selecting crypto transactions.  To help narrow down your transaction history you can search for the word "purchased" to find crypto purchases and the word "sold" to find crypto sales.  You can also search for the name of the cryptocurrency (like "bitcoin")" if you only have one type of crypto.
     
  4. Click on a particular purchase or sale to expand its details.
    The details will show the date and time of transaction, the exchange rate at the moment of transaction, the number of cryptocurrency "coins" involved and the value at that moment.  There is a convenient "Print Details" button which makes it easy to print out a paper copy for your records.
A PayPal crypto transaction record.
( Click to see full-size. )



Summary
There are three basic things to know about crypto:
  1. Crypto is volatile. 
    Value can go way up or way down at any moment.  If you trust history to be an indication of the future then stick to this rule:  Don't rush to sell during a downturn or else you'll guarantee your losses.  So far crypto has always increased in price when given enough time (potentially years).  Even so, only risk what can afford to lose.
     
  2. Crypto is not FDIC insured.
    Having crypto in an "exchange" (a crypto holding bank) is not like having money in an FDIC-insured bank account.  If your crypto is lost or stolen your crypto is -gone- so it is vital that you restrict your crypto business to highly-trusted, secure crypto exchanges.
     
  3. Treat crypto like stocks, not money.   
    For US citizens, crypto gains and losses are taxed the same way as gains and losses from buying and selling stocks.  As such, you will need to keep close record of each crypto purchase and each crypto sale (or trade) for tax purposes.  To avoid the short-term capital gains tax rate of 50%, plan to hold onto purchased crypto for at least 1 year before spending or cashing it.


Full disclosure: 
 
I have not been compensated in any way for this post (though I'm certainly open for offers - heh).

I have had a PayPal account since 1998 and currently have Cryptocurrency holdings through PayPal.  Some information in this post comes directly from my personal experience using PayPal's Cryptocurrency services.  At the end of my first two weeks of review for this post my combined initial investments in Bitcoin and Ethereum increased in value by 18%.  I fully expect price volatility will, at some point, reverse those gains to become losses.  I also anticipate that, long-term, my investments will eventually result in gains.  Still, there are no guarantees when it comes to investing in Cryptocurrencies -- play at your own risk and only with money you can afford to lose.  Good luck!




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