Cryptocurrency has become more mainstream in recent years. As a result, the IRS has paying more attention, especially as some estimate that the IRS is missing out on billions of taxes from unpaid crypto taxes.
What is Cryptocurrency?
Cryptocurrency uses cryptography to validate and secure transactions that are digitally recorded on a distributed ledger (such as a blockchain) or any similar technology.
In some environments, digital assets may operate like real currency, in other words, the coin and paper money of the United States or of any other country that is designated as legal tender, but they don’t have legal tender status in the U.S.
A digital asset that has an equivalent value in real currency or acts as a substitute for real currency has been referred to by the IRS as convertible virtual currency. Bitcoin is an example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros and other real currencies or digital assets.
IRS Considers Crypto a Digital Asset
The IRS classifies cryptocurrencies as a form of “digital assets,” which is defined as any digital representation of value that may function as a medium of exchange, a unit of account, and/or a store of value.
Digital assets may include (but are not limited to):
- Virtual currencies such as Bitcoin and Ether
- Stablecoins such as Tether and USD Coin (USDC)
- Non-fungible tokens (NFTs)
Virtual currency is treated as property by the IRS and general tax principles applicable to property transactions apply to transactions using virtual currency.
You’ll notice a question at the top of Form 1040 and Form 1040-SR asking about virtual currency transactions. All taxpayers must check the box indicating either “yes” or “no” when filling out these forms.
Common Virtual Currency Taxable Transactions
- The receipt of virtual currency as payment for goods or services provided
- The receipt or transfer of virtual currency for free (not qualified as a bona fide gift)
- The receipt of new virtual currency as a result of mining and staking activities
- The receipt of virtual currency as a result of a hard fork
- An exchange of virtual currency for property, goods or services
- An exchange/trade of virtual currency for another virtual currency
- A sale of virtual currency
- Any other disposition of a financial interest in virtual currency
In addition, the IRS also points out that the sale, exchange or transfer of any virtual currency that was held as a capital asset, would also result in the taxpayer checking “Yes” on the question and using Form 8949 to figure their capital gain or loss, including reporting it on Schedule D (Form 1040).
Likewise if you received any virtual currency as compensation for services or sold any virtual currency to customers in a trade or business, you must report the income as you would report other income of the same type (for example, W-2 wages on Form 1040 or 1040-SR, line 1, or inventory or services from Schedule C on Schedule 1).
Recordkeeping for Cryptocurrency Tax Transactions
What else should taxpayers know about cryptocurrency? Be aware that the Internal Revenue Code and regulations require taxpayers to maintain records that are sufficient to establish the positions taken on tax returns.
Taxpayers engaged in cryptocurrency should maintain records and documentation for:
- Other dispositions of virtual currency
Be sure to document the fair market value of the virtual currency.
For more information on virtual currency, read the IRS FAQ on virtual currency transactions.
If you have questions, reach out to us at 314-961-1600 or contact us to discuss your situation.
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Nancy Landry brings over 20 years experience with tax services, accounting technology solutions and wealth management. She believes it is the goal of the tax professional to develop a partnership with clients, including in-depth tax planning and guidance. Nancy is a St. Louis native, and recently returned after spending time northeast Ohio and Colorado.
About Smith Patrick CPAs
Smith Patrick CPAs is a boutique, St. Louis-based, CPA firm dedicated to providing personal guidance on taxes, investment advice and financial service to forward-thinking businesses and financially active individuals. For over 30 years, our firm has focused on providing excellent service to business owners and high-net worth families across the country. Investment Advisory Services are offered through Wealth Management, LLC, a Registered Investment Advisor.