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What should I do if I don't have adequate records of my capital gains in 2013? What is the best course of action to mitigate any potential issues from an IRS audit?

I have yet to submit my tax return. Should I just give my best guess? Or...?

  • Ask for the records from whoever you used for the buying and selling of the security so that you can compute your basis properly. – JB King Apr 12 '14 at 5:42
  • @JBKing I wish that were a possibility, but the exchange in question is Mt. Gox. Due to the legal troubles they are in right now, and since they took down their website (which had wonderful records before it got taken down), I'm not optimistic about getting the records through that route. – sdf Apr 12 '14 at 5:55
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    Can you reconstruct from notes, messages, withdrawals or deposits? If you used a dedicated bank account or dedicated btc wallet then you may be able to estimate gain or loss. – NL7 Apr 12 '14 at 6:22
  • @NL7, I have partial records, but after looking through what I have it looks like I am missing everything from April forward... I have a very rough guess of how much I made (~$1,000; a small fraction of my total income) but I have no idea how I would report an educated guess or even if doing so is advisable. My tax software certainly doesn't have a place to put an educated guess. – sdf Apr 12 '14 at 6:33
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    Don't you have records of the funds going out (of your checking/savings/etc) and then deposits back in? Shouldn't that tell you the gains? – JTP - Apologise to Monica Apr 12 '14 at 11:28
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You should at least look at your bank/paypal accounts. Mt.Gox wasn't sending out cash as sale proceeds was it? So you can find exactly how much you got. That is exactly what the IRS is going to do during audit.

Once you know how much you got - the problem is to show how much you paid for that, which is your basis. For that, especially if the difference is not significant (i.e.: you got $100K, but you paid $95K - you want to have $5K taxed, not the whole $100K), you need as much documentation as possible.

Start with your wallet and bank accounts again, and look for the related withdrawals that you can connect to the proceeds. In the wallet, look for arriving bitcoins (you'll need to trace it back all the way to your cash going out eventually, but that's a start) and check the average rates for that day.

If you don't have any reasonable records to establish basis - you'll get taxed on all the proceeds. The proceeds are easier to find.

You cannot use "educated guess".

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  • In the case that you have no records to establish basis, how do you fill out Form 8949? Can you enter a basis of 0? – Nate Eldredge Jan 27 '18 at 18:19
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This goes for any capital gain (or loss) for which you don't have adequate records. This happens all the time.

For tax purposes you need to know the following bits of information for any realized capital gain.

  • Description of asset (stock, bond, Picasso etching, bitcoin)
  • Date of purchase of asset
  • Cost of purchase of asset
  • Date of sale of asset
  • Proceeds from sale of asset

Capital gains (losses) can be realized in two ways.

  1. you sold the asset.
  2. you can demonstrate that the asset became worthless. In that case the date of sale is the date it became worthless, and the proceeds from the sale are zero.

If you don't know some of the bits of information, write yourself a memo making a good-faith estimate of them. If your grandmother gave you shares of Ford Motor Company, make a guess about the date she bought them, then go online and look up the share price on that day. (Usually the quoted online price takes splits aka stock dividends into account). Then multiply the share price by the number of shares you sold to guess the purchase cost.

Your guess about the day of purchase and the share price on that day are the basis of your good-faith estimates.

Then fill in your good-faith estimates in your tax return.

If the IRS audits you complaining about your estimates, send them a copy of your memo to yourself. Unless your surname happens to be Ford and you're talking about millions of shares, the IRS will probably say "OK." If they don't say "OK," you can ask them to give you an estimate of the tax liability for that item of capital gain.

If you are talking about millions of shares, why, ask your tax accountant to help you sort this out. You can afford a good tax accountant.

I'm not an attorney or a tax accountant.

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    Good faith estimate is not a valid documentation. Writing memo to yourself does not establish basis. If the IRS don't say OK - they will just assess the tax on the proceeds in their entirety, keeping track of your basis is your job. – littleadv Apr 12 '14 at 17:19
  • Of course writing a memo to yourself doesn't establish the basis beyond doubt. But it's a way to handle the situation where you can't establish the basis beyond doubt. – O. Jones Apr 12 '14 at 23:31

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