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Cryptocurrency and Taxes: How does taxation work on it?

Cryptocurrency and Taxes How does taxation work on it
Written by Taher Kameli & Shabnam Mahammadli

Cryptocurrency is a digital representation of value that can serve as a medium of exchange, a unit of account, and a store of value.[1] Although often held for investment purposes, the IRS has acknowledged that cryptocurrency may also be used in a manner similar to “real” currency, namely, to pay for goods or services. However, as no country has recognized any cryptocurrency as a form of legal tender, the IRS does not allow taxpayers to treat cryptocurrency as real currency, such as the US Dollar and the Euro.[2]

As a form of property excluded from the definition of real currency, we would look to the nature of the property to determine the tax consequences a sale or other disposition may cause. Notably, with limited exceptions (such certain business use property, inventory and property held for consumption) almost all property we own and use for personal or investment purposes will be considered a capital asset.[3] Accordingly, taxpayers would need to calculate their adjust basis in cryptocurrency[4] (often the amount paid to acquire it) and, with limited exceptions[5], would realize a capital gain when they sell cryptocurrency with a fair market value that exceeds their adjusted basis of the cryptocurrency and a capital loss when they sell cryptocurrency with a fair market value less than their adjusted basis of the cryptocurrency.[6]

While often a substantial undertaking, the IRS requires taxpayers to report their cryptocurrency transactions, other than the mere purchase of cryptocurrency with fiat (“real currency”). Moreover, proper reporting and planning can help taxpayers reduce their tax bill through various means (such as qualifying for long term gains, harvesting losses, donating appreciated cryptocurrency, and using specific identification) and avoid substantial penalties for underreporting your income or failing to report certain foreign accounts, both of which can lead to criminal prosecution.

The IRS has long had its eye on cryptocurrency transactions, and, while already receiving information from crypto exchanges, the IRS will also use the current Form 1040 U.S. Individual Income Tax Return to require taxpayers to declare, under penalties of perjury, whether or not, they have received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency at any time during 2020.[7] While the IRS subsequently released guidance that taxpayers need not check “yes” if their only transaction of cryptocurrency was a purchase of cryptocurrency with real currency, taxpayers must declare all other transactions and report any gains or losses, as applicable.[8]

The experienced crypto tax attorneys at the Law Offices of Kameli and Associates can help make your cryptocurrency reporting simple. We work with everyone from casual traders to major market players to provide clear and meaningful guidance on their unique tax aspects of their crypto portfolios. Call us today to discuss how we can help you stay out of the IRS’s warpath and make the most of your crypto gains with comprehensive tax planning strategies.

 

[1]  IRS Virtual Currency Guidance: Frequently Asked Questions, I.R.S. Notice 2014-21, 2014-16.

[2] Id.

[3] See, I.R.C. § 1221.

[4] See, Basis of Assets, I.R.S. Pub. No 551 (2018).

[5] See, Sales and Other Dispositions of Assets, I.R.S. Pub. No. 544 (2019).

[6] IRS Virtual Currency Guidance, I.R.S. Notice 2014-21, 2014-16.

[7] I.R.S. Form 1040 (2020).

[8] See generally, IRS Virtual Currency Guidance: Frequently Asked Questions, I.R.S. Notice 2014-21, 2014-16.