Is there a cryptocurrency tax? If you've invested in Bitcoin or another form of cryptocurrency, understand how the IRS taxes these types of investments and what constitutes a taxable event.
Interest in cryptocurrency has grown tremendously in the last several years. Whether you accept or pay with cryptocurrency, invested in it, are an experienced currency trader or you received a small amount as a gift, it's important to understand cryptocurrency tax implications.
Cryptocurrency's appeal as an alternative payment method
The term cryptocurrency refers to a type of digital asset that can be used to buy goods and services, although many people invest in cryptocurrency similarly to investing in shares of stock. Part of its appeal is that it's a decentralized medium of exchange, meaning it operates without the involvement of banks, financial institutions, or other central authorities.
Cryptocurrency is also secure; transactions are encrypted with specialized computer code and recorded on a blockchain — a public, digital ledger in which every new entry must be reviewed and approved by all network members.
You may have heard of Bitcoin or Ethereum as two of the more popular cryptocurrencies, but there are thousands of different forms of cryptocurrency worldwide.
How cryptocurrency transactions are taxed
People might refer to cryptocurrency as a virtual currency, but it's not a true currency in the eyes of the IRS. According to IRS Notice 2014-21, the IRS considers cryptocurrency to be property, and capital gains and losses need to be reported on Schedule D and Form 8949 if necessary.
Like other capital gains and losses, your gain may be short-term or long-term, depending on how long you held the cryptocurrency before selling or exchanging it.
- If you owned the cryptocurrency for one year or less before spending or selling it, any profits are typically short-term capital gains, which are taxed at your ordinary income rate.
- If you held the cryptocurrency for more than one year, any profits are typically long-term capital gains, subject to long-term capital gains tax rates.
How you report cryptocurrency on your tax return depends on how you got it and how you used it.
If you mine cryptocurrency
Cryptocurrency mining refers to solving cartographic equations to validate and add cryptocurrency transactions to a blockchain. In exchange for this work, miners receive cryptocurrency.
If you earn cryptocurrency by mining it, it's considered taxable income and might be reported on Form 1099-NEC at the fair market value of the cryptocurrency on the day you received it just as if it were self-employment income. You need to report this taxable income even if you do not receive a 1099 form.
If you receive cryptocurrency as payment for goods or services
Many businesses now accept Bitcoin and other cryptocurrency payments. If someone pays you cryptocurrency in exchange for goods or services, the payment counts as taxable income, just as if they'd paid you via cash or check. For tax reporting, the dollar value that you receive for goods or services is equal to the fair market value of the cryptocurrency on the day you received it.
If you sell or spend cryptocurrency
If you mine, buy, or receive cryptocurrency and eventually sell or spend it, you have a capital transaction resulting in a gain or loss just as you would if you sold shares of stock. This is where cryptocurrency taxes can get complicated.
For example, let's say you receive $200 worth of the cryptocurrency Litecoin in exchange for services on January 15. Six months later, on July 15, the fair market value of your Litecoin has increased to $400, and you use it to buy plane tickets for a vacation. On your tax return for that year, you should report $200 of ordinary income for receiving the Litecoin in January and a short-term capital gain of $200. That's the $400 value of your Litecoin when you purchased the plane tickets, minus your $200 basis when you received the Litecoin.
Those two cryptocurrency transactions are easy enough to track. But imagine you purchase $1,000 worth of Litecoin, load it onto a cryptocurrency debit card, and spend it over several months on coffee, groceries, lunches, and more. If, like most taxpayers, you think of cryptocurrency as a cash alternative and you aren't keeping track of capital gains and losses for each of these transactions, it can be tough to unravel at year-end.
If you exchange one type of cryptocurrency for another
Cryptocurrency enthusiasts often exchange or trade one type of cryptocurrency for another. For example, say you have $1,000 worth of Litecoin and exchange it for $1,000 worth of Ethereum. If you originally paid $300 for the Litecoin, you have to recognize a $700 capital gain when you make the exchange.
IRS increasing enforcement of cryptocurrency tax reporting
The IRS estimates that only a fraction of people buying, selling, and trading cryptocurrencies were properly reporting those transactions on their tax returns. The agency provided further guidance on how cryptocurrency should be reported and taxed in October 2019 for the first time since 2014.
Beginning in tax year 2020, the IRS also made a change to Form 1040 and began including the question: "At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?"
If you check "yes," the IRS will likely expect to see income from cryptocurrency transactions on your tax return.
How to handle cryptocurrency transactions on your tax return
You can usually download a transaction report from your cryptocurrency exchange platform, including all of your buys, sells, and exchanges of cryptocurrency in your account. If all of your cryptocurrency transactions occur on one exchange, gathering the information you need to report transactions on your tax return should be relatively easy. If you have cryptocurrency transactions on several exchanges, you'll need to download several reports and enter the necessary information into your tax return from each report.
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