Cryptocurrency and Capital Gains Tax
Bitcoin quietly made its appearance on the world stage in 2014. Initially, cryptocurrencies were merely obscure novelties. They were discussed by niche circles in tech and academia, if at all. It was only with the arrival of significant gains in 2017 that Bitcoin, and the cryptocurrency space as a whole, exploded into the mainstream. Cryptocurrency investing quickly accelerated into a global phenomenon. As a result, tax on cryptocurrency drew the attention of financial authorities and regulators worldwide. The U.S. has been no exception.
Tax On Cryptocurrency – The Global Landscape
Cryptocurrency tax regulations differ globally. To date, no jurisdiction has officially classified any type of “digital asset” as money, currency, or legal tender. Regulatory agencies have only recently described digital assets as some amorphous form of property between financial instruments and commodities. As the institutional architecture supporting cryptocurrency use and investment develops, regulations will gradually become more uniform. For instance, we have already seen glimpses of the future with various “Bitcoin ETF” proposals put to the SEC since 2017. The development of cryptocurrency derived financial instruments will attract vigorous regulatory oversight.
The IRS’ Take
The Internal Revenue Service (“IRS”) uses the term “virtual currency” to describe various types of convertible cryptocurrency assets used as mediums of exchange. For example, current IRS guidance states, taxpayers must recognize any capital gain or loss on sales of virtual currencies. In addition, capital gains and losses must be recognized when exchanging virtual assets for property, goods, or for other cryptocurrencies. Gain or loss is calculated by taking the difference between the fair market value of the property received and the taxpayer’s adjusted basis (or cost value) for the currency exchanged. Therefore, fair market value is derived from the U.S. dollar value of the transaction at the time of its occurrence, as recorded by the cryptocurrency exchange used.
What if I received virtual currency through a peer-to-peer transaction without the involvement of a cryptocurrency exchange?
Fair market values for cryptocurrencies are determined as of the date and time of each transaction. This is recorded on each currency’s respective distributed ledger (a live currency-specific global list of all known crypto-wallets and transactions). Several freely available blockchain explorer tools allow taxpayers to document the exact date, time, and exchange rate of any transaction. This enables taxpayers to report accurate fair market values.
Will I have to recognize income, gain, or loss for transferring virtual currency from one of my multiple digital wallets/accounts to another?
No. Transfers of virtual currency between wallets, accounts, or digital addresses belonging to the same taxpayer are non-taxable events.
Where do I report my capital gain or loss from virtual currency?
Taxpayers must calculate and report capital gains and losses on most sales and capital transactions in accordance with IRS Form 8949, Sales and Other Dispositions of Capital Assets. Next, taxpayers must summarize capital gains and deductible capital losses on Form 1040, Schedule D, Capital Gains and Losses.
Where do I report my ordinary income from virtual currency?
Taxpayers must report ordinary income derived from virtual currencies on Form 1040, U.S. Individual Tax Return, Form 1040-SS, Form 1040-NR, or Form 1040, Schedule 1, Additional Income and Adjustments to Income, as applicable.
What records do I need to maintain regarding my virtual currency transactions?
The IRS requires taxpayers to maintain records. They must be sufficient to establish the positions taken and reported on forms and returns submitted to them. Taxpayers should maintain records documenting receipts, sales, exchanges, or other dispositions of virtual currency along with some approximate fair market value.
Prudent taxpayers should only utilize cryptocurrency exchanges offering functionality for users to export complete transaction and trade histories at the individual trade level. Exported data should be in .csv or excel format to facilitate tax preparation.
Published by Arin Nahapatian