Bitcoin, Dogecoin, and Litecoin, oh my! If you have been watching the stock market at all in recent years, you have probably heard of cryptocurrency or crypto. You have likely seen people become millionaires overnight from these “coins,” but what is cryptocurrency? How does it even work? Do you have to pay taxes on it? RJS Law is here to give you a short guide to cryptocurrency and your taxes.
What is it?
Crypto is software at its most basic level. Some people use it as a form of currency to pay for goods and services. Others use it as an investment vessel like a stock or bond. You can “mine” cryptocurrency as a source of income, or you can simply trade or purchase it on an exchange similar to any other stock.
When is it taxed?
Cryptocurrency is generally considered income for tax purposes. The IRS requires you to record the fair market value of the crypto you receive on the day you receive it. You must then include that fair market value as part of your gross income on your taxes. This applies to crypto received via “mining” in addition to cryptocurrency received as payment for goods or services.
Crypto is generally taxed as property, not currency. If you sell your cryptocurrency, you will be taxed on the gain, and when you “spend” cryptocurrency, the IRS treats that as if you are selling it and requires you to pay capital gains taxes on the realized profit. Forbes gives the following example:
Let’s say you bought $20 worth of Bitcoin and held it as it rose in value to $200. If you used the bitcoin to buy $200 worth of groceries, you’d owe capital gains taxes on the $180 in profit you’d realized—even though it seems as if you spent the Bitcoin, rather than sold it. For the IRS, it’s the same thing.
When is it not taxed?
You do not generally owe taxes on your crypto before you have actually completed a trade or transaction. For example, if the value of your $50 of cryptocurrency increases to $50,000 overnight, the IRS does not generally consider this realized income until you trade or use that crypto and benefit from that increase in value. Therefore, if you do not complete any transactions with your crypto within a given tax year, you generally will not owe taxes on that cryptocurrency (exceptions may occur when trading one type of crypto for another).
When using or trading crypto, you generally do not owe taxes on your cryptocurrency if its value stayed the same. However, if the value decreased, you may be able to declare part of the loss to offset other investment gains.
How is the IRS cracking down on cryptocurrency?
Cryptocurrency raises tax evasion concerns, and the IRS has implemented new rules to tighten reporting. Any transaction of crypto with a fair market value of $10,000 or more now needs to be reported to the IRS using a Form 1099. However, it is highly recommended to report any and all of your cryptocurrency transactions to avoid potential tax issues and penalties. You should of course report all income received from crypto trades on your tax return and if there is any doubt, report. The IRS and Treasuring Department will likely become increasingly involved in the cryptocurrency asset class as time goes on, making it important that you abide by the rules.
This is a brief overview of cryptocurrency and taxation, it is not intended to cover every situation. RJS Law has tax professionals here to help you navigate the confusing world of crypto to help you avoid any problems comes tax season.
Published by Gwendolyn K. Davis