With some investors seeing substantial profits in cryptocurrency, governments understandably want to take in cryptocurrency taxes.
But since cryptocurrency trading is a relatively new type of investment, investors are still struggling to learn how to report different cryptocurrency transactions on their taxes. Bitcoin has only been around since 2009, and it wasn’t until 2014 that the Internal Revenue Service (IRS) first acknowledged its existence.
What every cryptocurrency investor should know: The IRS treats crypto as property, so in general, a cryptocurrency tax is similar to a tax involving a property transaction.
Do I Have to Report Cryptocurrency On Taxes?
The IRS declared cryptocurrency to be a form of property in April 2014. Broadly speaking, this makes the asset class subject to capital gains taxes.
And yet, one confusing aspect of the IRS communications surrounding cryptocurrency taxes is their use of the term “virtual currency.” Despite classifying crypto as a form of property, the agency still refers to the asset class as a currency.
The official IRS website states the following: “The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability.”
There is a full IRS statement on the subject called “Notice 2014-21 .” This document answers many of the most frequently asked questions surrounding taxes and cryptocurrency.
4 Situations When You Need to Report Crypto on Your Taxes
Here’s a quick rundown of four situations in which a taxpayer will need to report their cryptocurrency transactions, as covered in Notice 2014-21.
1. Receiving Payment in Cryptocurrency
Taxpayers, including independent contractors, who receive payment for goods or services in the form of cryptocurrency are required to factor this payment into their income.
Doing so requires including the fair market value of the cryptocurrency on the date that the crypto was received. All cryptocurrency transactions must be reported in U.S. dollars. To determine fair market value, taxpayers must determine the value of the coin as measured in U.S. dollars at the time of receipt.
IRS Publication 525 can be referenced for issues regarding taxable income.
2. Mining Cryptocurrency
Individuals who pursue cryptocurrency mining as their business have to pay taxes on the cryptocurrency they earn as a result.
In this case, the crypto earned becomes subject to the self-employment tax. IRS Publication 334 has more information on self-employment taxes and Publication 535 has more information on business taxes.
3. Cryptocurrency Hard Forks
Hard forks that involve the creation of a new coin generate additional income for the recipient, and are treated as such. Bitcoin holders who received Bitcoin Cash (BCH) on August 1st, 2017, for example, might owe taxes on the BCH they received.
“Airdrops,” which are random distributions of new coins for marketing purposes, are also treated as additional income.
4. Payments Made Using Cryptocurrency
When someone pays for goods or services using crypto, the IRS considers the transaction “subject to information reporting to the same extent as any other payment made in property.”
Notably, this only applies to a payment of $600 or more in a taxable year. This provision was added to spare users the almost impossible task of calculating capital gains for many small purchases made using crypto.
Recent Cryptocurrency Tax Changes
In recent years, the IRS has become more targeted in their efforts to get taxpayers to report gains and losses in their crypto portfolios.
In 2019, the agency sent letters to 10,000 taxpayers notifying them that they may owe back taxes, penalties, and interest on cryptocurrency transactions.
In 2020, for the first time, all taxpayers were required to answer a question regarding cryptocurrency taxes on their 2019 tax returns. The question simply asks if a taxpayer has engaged in taxable transactions involving cryptocurrency, including receiving, selling, sending, exchanging, or otherwise acquiring any financial interest in any virtual currency. (Buying cryptocurrency does not constitute a taxable event.)
The IRS later elaborated on what it means to have a “financial interest” in virtual currency:
• Receiving crypto from a fork or airdrop
• Selling crypto
• Exchanging crypto for goods or services
• Exchanging crypto for other property, including other cryptocurrencies.
The IRS appears newly determined to find and prosecute crypto users who haven’t reported crypto taxes. Taxpayers who falsify their answer to the cryptocurrency question on their tax returns could face penalties and perhaps even criminal investigations later on.
How Is Crypto Tax Calculated?
For investors who only buy cryptocurrency and never sell ( these investors are sometimes called “HODLers”), their taxes might be easy. With no selling activity, there are no realized gains, and so there may be no capital gains taxes to pay.
For those who have realized gains, however, there could be taxes due.
One common method for determining fair market value for anything subject to capital gains tax is the “first-in, first-out” (FIFO) method. With FIFO, the first sale made must be compared to the first purchase made to determine profits or losses.
For example, if 20 items were purchased for $10 and 10 more items were purchased next for $15, FIFO would assign the cost of the first item resold of $10. After 20 items were sold, the new cost of the item would become $15.
Whenever an investor sells coins, calculating the profit or loss can be accomplished by looking at the first buy order for that coin. The second sell order would then look at the second buy order. The third sell order would look at the third buy order, and so on.
Things can get tricky when trying to calculate many different transactions over time for many different coins and amounts of coins.
Luckily, exchanges and other third-parties have developed software to help investors cope with these challenges. In addition, many cryptocurrency exchanges keep logs of user transactions. This data is typically available for download as a .csv file.
FIFO isn’t the only method for calculating capital gains tax, but it’s one of the more commonly-used and straightforward ones.
When an investor profits from crypto transactions, they can be subject to taxes. Those transactions include buying low and selling high, exchanging one crypto for another, or benefiting from a hard fork.
Of course, capital losses can also be reported and could reduce an investor’s overall tax burden in some cases.
Since the IRS first declared cryptocurrency taxable in 2014, a number of software programs and services have arisen to help investors with the complicated task of reporting cryptocurrency transactions on their taxes. There is also a growing number of tax lawyers and accountants who specialize in this area.
For investors trying to make sense of their individual cryptocurrency tax responsibilities, it may be helpful to consult with a certified tax professional to determine the best course of action for their individual situation.
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