4 Things to Know About Cryptocurrency and Taxes
Updated: Feb 16, 2022
Cryptocurrency is a fun new emergence in the hyperreality of value. It’s a form of currency that is removed from any central monetary authority, located exclusively online. Some well-known examples include Bitcoin, Ethereum, NFT's and Dogecoin. Bitcoin originally became popular for its ability to secure the anonymous trading of value for goods or services online. But these days, from investors seeking long-term gains to athletes demanding e-payment, the varied nature of virtual currency has led many to buy-in to its value.
One thing that hasn't changed is the IRS and their expectation that taxpayer’s report their profits – even if digital.
1. Report Cryptocurrency like stock - The first page of 1040 will ask you about your crypto trading: “At any time during the last tax year did you receive, sell, send, exchange, or otherwise dispose of any financial interest in any virtual currency?” This is obviously a very broad question, but it basically asks if you have had an exchange of value using virtual currency. If you have merely bought and held cryptocurrency, there is no need to report it. If you sold it, however, for-profit or for loss, you need to report it. If you exchanged one type of crypto for another (E.g., Bitcoin for Ethereum), you will need to report it. Was cryptocurrency airdropped into your wallet without your knowledge? If it has value, then yes, you need to report it.
2. Profits earned Mining Virtual Currency is considered Self-Employment Income - The IRS has decided to generally tax crypto as capital-gains property. However, if you receive it in exchange for services you perform, it will be taxed as regular income based on the fair market value at the time of receipt. If you embark on the process of “mining” virtual currency, and the “mining” activity is not undertaken as an employee, the net earnings from such activity constitute self-employment income and may be subject to the self-employment tax. If you exchange your crypto for other property or virtual currency, you will recognize a long or short-term capital gain or loss, depending on whether the crypto was held as a capital asset for more or less than a year, and on the relative fair market values at the times of the trade.
3. Many of the more popular Online Trading Platforms will report your Crypto Activity - You can buy and trade crypto on an exchange, which is akin to a brokerage for a stock. The exchanges are bound by U.S. law to report your crypto activity to the IRS. This is part of why the IRS will know if you do not report your crypto activities. While the crypto economy is only about 10% of the volume of the New York Stock Exchange, it has become popular enough for the IRS to take notice and start taking their cut.
4. Track Your Basis – This dual nature can make the prospect of tracking crypto taxes somewhat perplexing. The simplest strategy is to view each transaction the same way we do with stocks and other similarly situated financial instruments. As such, tracking your cost basis (or acquisition cost) is essential to accurately calculate your tax liability since it represents the starting point for any gain calculation. The more challenging equations begin when purchasing the same asset at different price points. Because the asset sold may not necessarily be the asset purchased, a method of accounting must be employed using an inventory valuation method such as FIFO or LIFO.
Cryptocurrency has gone mainstream and proved more than a fad or passing trend, so it is probably time to implement best practices for tracking your crypto transactions. It has captured the imagination of the public and it has captured the interest of the IRS. For, it is volatile, it is mysterious... it is taxable.